NCERT Solutions for Commerce Accountancy Class 12 Cash Flow Statement-

Short Answer Questions

Q1: What is a Cash Flow Statement?
Ans: A cash flow statement shows the inflows and outflows of cash and cash equivalents arising from a company's operating, investing and financing activities during an accounting period. It records receipts and payments of cash and cash equivalents and helps users to assess the company's ability to generate cash, meet its obligations and fund its operating and investing needs.

Q2: How are the various activities classified (as per AS-3 revised) while preparing cash flow statement?
Ans: As per AS-3, cash flows are classified into three categories:
Operating activities: These are the principal revenue-producing activities of the enterprise and other activities that are not investing or financing activities. For example, a garment manufacturer's operating activities include cash receipts from sale of garments and cash payments for raw materials and manufacturing expenses.
Investing activities: These relate to the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Examples include cash paid to purchase plant and machinery and cash received on sale of a fixed asset.
Financing activities: These are activities that result in changes in the size and composition of the owners' capital and borrowings. Examples include cash proceeds from issue of equity shares or debentures and cash repayments of long-term borrowings.

Q3:  State the objectives of cash flow statement.
Ans: The main uses of a cash flow statement are: 

• To provide information about changes in the financial structure and net assets of an enterprise and the amount generated by cash inflows.
• To show the company's capacity to generate cash and cash equivalents, enabling assessment of liquidity and solvency.
• To allow comparison of operating performance between enterprises by focusing on cash flows rather than accounting treatments.
• To present transactions at historical cash values, which helps users obtain reliable information about actual cash movements.

Q4: What are the objectives of preparing cash flow statement?
Ans: The important objectives of preparing a cash flow statement are as follows:

1. To ascertain the gross inflows and outflows of cash and cash equivalents from operating, investing and financing activities.
2. To analyse the reasons for changes in cash balances during the accounting period.
3. To assess the liquidity and solvency of the company by showing its ability to generate cash to meet short-term and long-term obligations.
4. To help management and other users determine the company's future cash requirements and the sources of cash to meet those needs.

Q5: State the meaning of the terms:
(i) Cash Equivalents,
(ii) Cash flows.
Ans:
(i) Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash and are subject to an insignificant risk of change in value. They are held to meet short-term cash commitments rather than for investment or other purposes.
(ii) Cash flows are movements of cash and cash equivalents into and out of an enterprise. A cash inflow arises when cash is received (for example, from sale of goods), and a cash outflow arises when cash is paid (for example, to purchase assets or settle liabilities).

Q6: Prepare a format of cash flow from operating activities.
Ans: The following is the standard format used to present cash flows from operating activities. It shows how net profit is adjusted for non-cash and non-operating items and for changes in working capital to arrive at net cash from operating activities.

Q 7: State clearly what would constitute the operating activities for each of the following enterprises:
(i) Hotel
(ii) Film production house
(iii) Financial enterprise
(iv) Media enterprise
(v) Steel manufacturing unit
(vi) Software development business unit
Ans: The operating activities for the enterprises are as follows: 
(i) Hotel: Cash receipts from room rentals, food and beverages, and other services are operating inflows. Cash payments for salaries, groceries, utilities and other day-to-day expenses are operating outflows.
(ii) Film production house: Cash receipts from sale of film rights, distribution deals and licensing are operating inflows. Payments to actors, location expenses and production costs are operating outflows.
(iii) Financial enterprise: Cash receipts from repayment of loans and interest income are operating inflows for a financial institution. Operating outflows include payments of salaries and day-to-day administrative expenses. (Note: classification of interest depends on the nature of the enterprise.)
(iv) Media enterprise: Cash receipts from advertising revenues and subscription fees are operating inflows. Payments of salaries to staff and production expenses are operating outflows.
(v) Steel manufacturing unit: Cash receipts from sale of steel products are operating inflows. Cash payments for purchase of raw materials, wages and factory overheads are operating outflows.
(vi) Software business unit: Cash receipts from sale of software, licences and maintenance contracts are operating inflows. Payments of salaries, subcontracting costs and other operating expenses are operating outflows.
Q8: "The nature/type of enterprise can change altogether the category into which a particular activity may be classified." Do you agree? Illustrate your answer.
Ans: Yes. The nature or type of an enterprise affects how certain cash flows are classified. For example, interest received or paid is treated differently depending on the enterprise: for a financial institution, interest received and interest paid are normally classified as operating activities because they form part of the principal revenue-earning operations. For a manufacturing company, interest paid is usually classified as a financing activity and interest received as an investing activity. Thus classification depends on the primary business activities of the enterprise.

Long Answer Questions

Q1: Describe the procedure to prepare Cash Flow Statement.
Ans: The procedure to prepare a cash flow statement is as follows: 

• Identify and determine cash flows from operating activities for the period.
• Identify and determine cash flows from investing activities (acquisition and disposal of long-term assets and investments).
• Identify and determine cash flows from financing activities (changes in equity and long-term borrowings).
• Aggregate the net cash flows from operating, investing and financing activities to find the net increase or decrease in cash and cash equivalents for the period.
• Add the opening balance of cash and cash equivalents to the net increase (or subtract the net decrease) to arrive at the closing balance of cash and cash equivalents.

Q2: Describe "Indirect" method of ascertaining Cash Flow from operating activities.
Ans: The indirect method begins with net profit or loss as reported in the profit and loss account and converts it into net cash flow from operating activities by making adjustments for non-cash and non-operating items and for changes in working capital. Key points are: 
- Start with net profit (or loss) for the year.
- Add back non-cash expenses such as depreciation and amortisation.
- Adjust for non-operating gains and losses (for example, deduct profit on sale of fixed assets or add back loss on sale of assets), since these are investing activities.
- Adjust for changes in working capital items (increase in receivables reduces cash; increase in payables increases cash), adding or deducting as appropriate.
The result is net cash generated from (or used in) operating activities, presented in the cash flow statement under the indirect method.

Q3: Explain the major Cash Inflows and outflows from investing activities.

Ans: Investing activities relate to acquisition and disposal of long-term assets and investments. Major cash inflows and outflows are: 

Cash inflows (examples): 

• Proceeds from sale of fixed assets (e.g. sale of machinery). 
• Proceeds from sale of investments or from maturity of long-term investments. 
• Cash outflows (examples): 
• Cash paid to acquire fixed assets (e.g. purchase of machinery). 
• Cash paid to acquire long-term investments. These inflows and outflows indicate the company's investment in its long-term productive capacity.

Q4: Explain the major Cash Inflows and outflows from financing activities.

Ans: Financing activities involve changes in the size and composition of the company's equity and borrowings. Major cash inflows and outflows include: 

• Cash inflows (examples): 
• Proceeds from issue of shares or other equity instruments. 
• Proceeds from long-term borrowings (e.g. loans, debentures). 
• Cash outflows (examples): 
• Repayment of long-term borrowings. 
• Payment of dividends to shareholders. 
• Redemption of debentures or repayment of finance leases. 

Note: Classification of interest paid and interest received may depend on the nature of the enterprise (for financial institutions these are often operating activities; for other enterprises interest paid is usually financing and interest received is investing).