Question 1

Positive free cash flow suggests that the company did not generate enough cash flow from its operating activities to fund its capital expenditures and dividend payments.

Accepted Answer

Positive free cash flow means that the company generated more cash from its operating activities than it spent on capital expenditures and dividend payments. It is a good sign for investors, as it shows that the company has enough cash to fund its investments and reward shareholders.

Question 2

For purposes of preparing a the statement of cash flows, cash equivalents consist of short-term, highly liquid investments such as treasury bills, commercial paper, and money market funds that are made solely for the purpose of generating a return on funds that are temporarily idle.

Accepted Answer

This statement is true. Cash equivalents are defined as short-term, highly liquid investments that are easily convertible into cash and carry minimal risk of value changes. Examples of cash equivalents include treasury bills, commercial paper, and money market funds, among others. These investments are made for generating a return on funds that are temporarily idle and are included in the statement of cash flows as part of a company's cash and cash equivalents balance.

Question 3

A newly formed company with enormous growth prospects would be expected to have positive free cash flow during its start-up phase.

Accepted Answer

During the start-up phase, a company typically incurs high initial costs and investments in order to establish its operations and gain market share. This often results in negative free cash flow, as the company's cash outflows exceed its inflows. It is not until the company reaches a mature stage with established operations and a strong customer base that it is more likely to have consistently positive free cash flow.

Question 4

In the statement of cash flows, increases in a company's capital stock accounts are treated as a "use" rather than as a "source" of cash.

Accepted Answer

Increases in a company's capital stock accounts are treated as a "source" of cash in the statement of cash flows because the company is receiving cash inflows from investors who are purchasing the new shares of stock.

Question 5

An increase in the accumulated depreciation account of $50,000 over the course of a year would be shown on the company's statement of cash flows prepared under the indirect method as:
A) an addition to net income of $50,000 in order to arrive at net cash provided by operating activities.
B) a deduction from net income of $50,000 in order to arrive at net cash provided by operating activities.
C) an addition of $50,000 under investing activities.
D) a deduction of $50,000 under investing activities.

Accepted Answer

Accumulated depreciation is a non-cash expense. Under the indirect method, it is added back to net income to calculate net cash provided by operating activities.

Question 6

When computing the net cash provided by operating activities under the indirect method on the statement of cash flows, a decrease in common stock would be added to net income.

Accepted Answer

A decrease in common stock would not be added to net income, rather it would be shown as a financing activity in the statement of cash flows.

Question 7

When using the indirect method to prepare the statement of cash flows, depreciation should be presented as a(n):
A) cash flow from investing activities.
B) cash flow from financing activities.
C) deduction from net income.
D) addition to net income.

Accepted Answer

Depreciation is a non-cash expense and is added back to net income in the operating activities section when using the indirect method to prepare the statement of cash flows.

Question 8

Transactions that involve acquiring or disposing of noncurrent assets are generally classified as investing activities on the statement of cash flows.

Accepted Answer

Transactions involving noncurrent assets such as property, plant, and equipment, or investments, are classified as investing activities on the statement of cash flows as they involve the acquisition or disposal of long-term assets that are not part of the company's normal operations.

Question 9

A change in deferred taxes is considered to be an investing activity on the statement of cash flows.

Accepted Answer

A change in deferred taxes is actually considered to be a non-cash reconciling item and is therefore included in the "Cash Flow from Operating Activities" section of the statement of cash flows, not the "Cash Flow from Investing Activities" section.

Question 10

Drusilla Corporation prepares its statement of cash flows using the indirect method. Which of the following would be deducted from net income in the operating activities section of the statement? 
A) Choice A
B) Choice B
C) Choice C
D) Choice D

Accepted Answer

The answer of Drusilla Corporation prepares its statement of cash...

Question 11

Free cash flow is net cash provided by operating activities less capital expenditures and dividends.

Accepted Answer

Free cash flow is calculated by subtracting capital expenditures and dividends from net cash provided by operating activities.

Question 12

The issuance of a stock dividend will appear in the financing activities section of the statement of cash flows.

Accepted Answer

The issuance of a stock dividend is considered a non-cash transaction and therefore does not appear in the financing activities section of the statement of cash flows. It may be disclosed in the notes to the financial statements.

Question 13

Which of the following would be considered a "use" of cash for purpose of constructing a statement of cash flows?
A) selling the company's own common stock to investors.
B) issuing long-term debt.
C) purchasing equipment.
D) amortizing a patent.

Accepted Answer

Purchasing equipment requires the use of cash and would be considered a cash outflow in the statement of cash flows.

The other options:

A) Selling the company's own common stock to investors would be considered a cash inflow in the financing section of the statement of cash flows because it is a source of financing, not a use of cash.

B) Issuing long-term debt would also be considered a cash inflow in the financing section because it is a source of financing.

D) Amortizing a patent would not be considered a use of cash because it is a non-cash expense that is added back to net income in the operating section of the statement of cash flows.

Question 14

Under the indirect method of determining the net cash provided by operating activities on the statement of cash flows, increases in current assets such as prepaid expenses are subtracted from net income.

Accepted Answer

The indirect method subtracts increases in current assets such as prepaid expenses from net income in order to determine the net cash provided by operating activities.

Question 15

In a statement of cash flows, a change in prepaid expenses would be classified as:
A) an operating activity.
B) a financing activity.
C) an investing activity.
D) a noncash item that need not appear on the statement of cash flows.

Accepted Answer

Prepaid expenses represent a payment made in advance for goods or services that will be received in the future. As such, they are typically classified as an operating activity on the statement of cash flows because they relate to the company's day-to-day operations.

Question 16

Negative free cash flow invariably signals poor performance.

Accepted Answer

Negative free cash flow can occur for a variety of reasons, such as investments in growth opportunities, acquisitions, or paying down debt. Therefore, it is not always a sign of poor performance. It may be a strategic decision by the company to invest in future growth. However, if negative free cash flow persists for an extended period, it may indicate that the company is not generating enough cash from its operations to support its growth or debt obligations, which can lead to financial distress.

Question 17

Which of the following would be considered a "use" of cash for purposes of constructing a statement of cash flows?
A) an increase in accounts payable.
B) an increase in prepaid expenses.
C) an increase in accrued liabilities.
D) an increase in accumulated depreciation.

Accepted Answer

An increase in prepaid expenses represents a use of cash because it involves paying cash upfront for expenses that will be recognized in future periods.

Question 18

Activities such as the purchase of inventory on account should be included as part of a company's financing activities on the statement of cash flows.

Accepted Answer

Activities such as the purchase of inventory on account should be included as part of a company's operating activities on the statement of cash flows, not financing activities. Financing activities include things like issuing stocks or bonds, paying dividends, or taking out loans.

Question 19

When a company prepares its statement of cash flows under the indirect method, an increase in depreciation expense will also increase the net cash provided by operating activities.

Accepted Answer

An increase in depreciation expense is a non-cash expense, meaning it does not involve an actual outflow of cash. Therefore, it is added back to net income when calculating net cash provided by operating activities under the indirect method. This means there is no direct impact on net cash provided by operating activities from an increase in depreciation expense.

Question 20

For external reporting purposes, the FASB recommends the indirect method of determining the net cash provided by operating activities on the statement of cash flows.

Accepted Answer

The FASB allows both the direct and indirect methods for reporting cash flows from operating activities, but it does not specifically recommend one over the other. However, the indirect method is more commonly used in practice.

Quiz 15: How Well Am I Doing Statement of Cash Flows