Solman 12 Second Ed

CHAPTER 12
STATEMENT OF CASH FLOWS

QUESTIONS
1. Though the profit and loss statement provides information about an enterprise's
financial performance during a period, it does not show the cash generated through an
enterprise's operations because earnings are measured by accrual accounting. The
balance sheet provides information about an enterprise's asset and how these assets
have been financed by owned and borrowed funds at a point of time, but it does not
explain the changes during a period in assets, obligations, and owner's equity resulting
from an enterprise's activities. Therefore, a statement providing information on the
major sources of cash receipts and cash outlays is needed.
2. Cash equivalents are short-term, highly liquid investments, including Treasury bills,
certificates of deposit, commercial paper, and money market deposits.
3. The primary purpose of the statement of cash flows is to provide relevant information
about the cash receipts and cash payments of an enterprise during a period.
4. The information in the statement of cash flows will help financial statement users to
assess the amounts, timing, and uncertainty of prospective cash flows to the enterprise.
The statement of cash flows is useful to investors, lenders, analysts, and others in
assessing an enterprise's liquidity, financial flexibility, profitability, and risk. It also
provides a feedback about previous assessments of these factors.
5. Cash flows are classified into three categories: Operating, Investing, Financing
activities. Examples for each category are as follows:
Operating activities : Cash receipts from customers for sale of goods and services and
cash payments to suppliers for purchase of materials.
Investing activities: Cash receipts from collections of loans and cash payments for
disbursements of loans.
Financing activities: Proceeds from issuing equity instruments and payment of

dividends.
6. Although non cash transactions do not result in cash inflows or outflows in the period
in which they occur, they generally have a significant effect on the prospective cash
flows of a company. For example, conversion of debt to equity will eliminate payments
of interest on the debt and a finance lease obligation requires future lease payments in
cash. Therefore, information about major non cash investing and financing activities is
usually provided in a note or schedule to the statement of cash flows.
7. The direct method shows major classes of operating cash receipts and payments, such
as cash received from customers, cash paid to suppliers and employees, and income tax
Statement of Cash Flows  Chapter 12 p.1
paid, the sum of which is net cash flow from operating activities. The indirect method
starts with net profit and adjusts it for revenue and expense items that did not involve
operating cash receipts or cash payments in the current period to arrive at net cash flow
from operating activities. Both methods result in the same figure of net cash flow from
operating activities.
8. Possible sources of the difference include: increase in debtors, increase in inventory,

gain on sale of fixed assets or investments, decrease in creditors, and decrease in bills
payable.
9. Classification of items:
a. A cash outflow from financing activities.

b. A cash inflow from investing activities.
c. A cash outflow from financing activities.
d. A cash inflow from investing activities.
e. A part of the sale price of related investments, hence a cash inflow from investing
activities, Under the indirect method, the gain is deducted from net profit.
f. Does not involve any cash flow.
g. A part of the cash outflow for redemption of debentures, hence a cash outflow
from financing activities. Under the indirect method, the gain is deducted from
net profit.
10. Adjustment of items:
a. Add to net profit.

b. Deduct from net profit.
c. Deduct from net profit.
d. Add to net profit.
e. Add to net profit.
f. Add to net profit.
11. The sale price of Rs 29,000 will appear as a cash inflow in the investing activities
section of the statement of cash flows.
12. None of a, b, and c involves any cash inflow or outflow. All of them will be shown in
the supplemental schedule of non-cash transactions.
13. Possible reasons include: increase in debtors , increase in inventory, decrease in

creditors, decrease in bills payable, net purchase of plant and machinery, net of
purchase of investments, payment of dividends, and redemption of debentures.
14. If the sum of net cash flows from investing and financing activities is negative and it
exceeds net cash flow from operating activities, it can be generally inferred that short-
term, operating cash flows have been used for long-term purposes.
p.2 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

EXERCISES
Exercise 12.1: Classification of Activities
a. None of the above. e. Non cash activity. i. Investing activity. m. Financing activity.
b. Financing activity. f. Financing activity. j. Operating activity,
extraordinary item.
c. Investing activity. g. Investing activity. k. Operating activity.
d. Investing activity. h. Financing activity. l. Non cash activity.
Exercise 12.2: Classification of Activities
a. None of the above. e. Operating activity. i. Non cash activity. m. Operating

activity.
b. Operating activity. f. Operating activity. j. Financing activity.
c. Non cash activity. g. None of the k. None of the
above. above.
d. Operating activity. h. Non cash activity. l. Non cash activity.
Exercise 12.3: Determining Net Cash Flow from Operating Activities

Direct Method
Praveen Company
Cash Flow from Operating Activities
For the Year Ended December 31, 20X5
Cash Received from Customers (1) Rs 4,74,000
Cash Paid to Suppliers and Employees (2) (2,71,000)
Income Tax Paid (3) (56,000)
Net Cash Provided by Operating Activities Rs 1,47,000
(1) (25,000 + 4,36,000 + 78,000 − 49,000 − 16,000).

(2) (2,69,000 + 61,000 − 43,000 − 7,000 + 62,000 + 51,000 + 3,000 − 67,000 − 39,000 −
19,000).
(3) (53,000 + 14,000 − 11,000).
Exercise 12.4: Determining Net Cash Flow from Operating Activities

Indirect Method
Ajay Company
Net Profit Rs 3,40,000
Adjustments to Reconcile Net profit to Cash Flow from
Operating Activities
Depreciation Expense 49,000
Gain on Sale of Investments (8,000)
Decrease in Inventory 13,000
Increase in Debtors (33,000)
Increase in Prepaid Expenses (11,000)
Increase in Creditors 4,000
Decrease in Income Tax Payable (6,000)
Total Adjustments 8,000
Net Cash Provided by Operating Activities 3,48,000
Exercise 12.5: Determining Net Cash Flow from operating Activities

Direct Method
Abhijit Company
Net Cash Provided by Operating Activities Rs 70,000
(1) (7,29,000 + 92,000 − 97,000 − 4,000).

(2) (4,85,000 + 56,000 − 45,000 − 29,000 + 68,000 + 81,000 + 74,000 + 21,000 − 57,000 −
41,000 − 15,000).
(3) (67,000 + 33,000 − 48,000).
Exercise 12.6: Determining Net Cash Flow from Operating ActivitiesIndirect Method
Dutt Company
Net Profit Rs 89,000
Adjustments to Reconcile Net Profit to Cash Flow from
Depreciation Expense Rs 67,000
Provision for Doubtful Debts 15,000
Dividend from Subsidiaries (3,000)
Loss on Sale of Plant & Machinery 8,000
Increase in Inventory (14,000)
Interest Income (9,000)
Interest Expense 11,000
Decrease in Bills Payable (44,000)
Net Cash Provided by Operating Activities 91,000

Exercise 12.7: Determining Net Cash Flow from Investing Activities
Haveli Company
For the Year Ended March 31, 20X7
Cash Flow from Investing Activities
a. Purchase of Investments Rs (65,000)
b. Proceeds from Sale of Investments 34,000
c. Purchase of Plant & Machinery (1,58,000)
d. Construction of Building (78,000)
e. Proceeds from Sale of Plant and Machinery 52,000
Net Cash Used in Investing Activities Rs (2,15,000)
Exercise 12.8: Determining Net Cash Flow from Financing Activities
Supra Corporation
For the Year Ended November 30, 20X9
Cash Flow from Financing Activities
a. Dividend Paid Rs (12,000)
b. Redemption of Secured Debentures (47,000)
c. Payment of Unsecured Loans (21,000)
d. Proceeds from Issuance of Secured Convertible 1,70,000
Debentures
Net Cash Provided by Financing Activities Rs 90,000
Item e is a non cash transaction to be shown in a supplement schedule.
Exercise 12.9: Preparing the Statement of Cash Flows
Sikandar Company
Statement of Cash Flows
For the Year Ended March 31, 20X4
Purchase of Investments Rs (1,87,000)
Proceeds from Sale of Plant and Machinery 41,000
Proceeds from Sale of Patents 4,000
Purchase of Investments (23,000)
Proceeds from Sale of Investments 42,000
Interest Received 8,000
Net Cash Used in Investing Activities (1,15,000)
Proceeds from Issuance of Share Capital Rs 75,000
Dividend Paid (45,000)
Interest Paid (18,000)
Net Cash Provided by Financing Activities 12,000
Net Decrease in Cash and Cash Equivalents (26,000)
Cash and Cash Equivalent at Beginning of Period 70,000
Cash and Cash Equivalents at End of Period 44,000
(1) 9,73,000 + 1,56,000 − 2,09,000 = 9,20,000

(2) 6,85,000 + 53,000 − 49,000 − 14,000 + 194,000 + 15,000 + 1,06,000 + 12,000 − 1,98,000
− 29,000 = 7,75,000
(3) 67,000 + 7,000 − 6,000 = 68,000
PROBLEM SET A
Problem A-1: Classification of Activities
a. Operating activity. g. Non cash activity. m. Investing activity. s. Operating activity.

b. Investing activity. h. Operating activity. n. Operating activity. t. Operating activity.
c. Investing activity. i. Investing activity. o. Investing activity. u. Operating activity.
d. Investing activity. j. None of the p. Non cash activity.
above.
e. Non cash activity. k. Investing activity. q. Investing activity.
f. Financing activity. l. None of the r. Financing activity.
above.
Problem A-2: Cash Flow from Operating Activities
1. Cash Flow from Operating Activities-Direct Method
Gopal Dairy Company

For the Year Ended September 30, 20X7
(1) (2,71,000 − 12,000 − 2,000).

(2) (1,86,000 + 19,000 − 9,000 + 7,000 − 4,000).
(3) (8,000 − 3,000).

2. Cash Flow from Operating Activities-Indirect Method
Gopal Dairy Company

For the Year Ended September 30, 20X7
Net Profit Rs 7,000
Adjustments to Reconcile Net profit to Cash Flow from
Loss on Sale of Plant and Equipment 2,000
Decrease in Creditors (7,000)
Increase in Income Tax Payable 3,000
Problem A-3: Cash Flow from Operating Activities
Vijaya Company
For the Year Ended August 31, 20X3
Cash Flow from operating Activities
Income Tax Paid (3 (53,000)
Net Cash Provided by Operating Activities Rs
1,50,000
(1) (9,28,000 + 46,000 − 7,000).

(2) (8,12,000 + 43,000 + 73,000 − 59,000 − 87,000 − 18,000).
(3) (39,000 + 14,000).

Vijaya Company
For the Year Ended August 31, 20X3
Gain on Sale of Plant (11,000)
Loss on Sale of Investments 8,000
Decrease in Debtors 39,000
Interest Received (32,000)
Interest Paid 10,000
Problem A-4: Preparing and Interpreting the Statement of Cash Flows
1. Statement Cash Flows-Direct Method
Pioma Plastics Company

For the Year Ended April 30, 20X3
Cash Received from Customers (a) Rs 6,46,000
Cash Paid to Suppliers and Employees (b) (8,51,000)
Income Tax Paid (c) (1,16,000)
Insurance Proceeds Received 76,000
Net Cash Used in Operating Activities Rs (2,45,000)
Purchase of Plant and Machinery Rs (53,000)
Proceeds from Sale of Land 1,33,000
Dividend Received 20,000
Net Cash Provided by Investing Activities 1,73,000
Proceeds from Issuance of Secured Debentures 6,000
Proceeds from Issuance of Unsecured Loans 48,000
Cash and Cash equivalent at Beginning of Period 1,33,000
Supplemental Schedule of Non-cash Investing and Financing Activities: During the year, the
company purchased machinery for Rs 78,000 in exchange for secured debentures.
(a) (7,58,000 + 1,18,000 − 2,16,000 − 14,000)

(b) 5,37,000 + 1,23,000 − 93,000 − 11,000 + 63,000 + 1,47,000 + 1,65,000 + 8,000 − 19,000
− 11,000 − 38,000 − 20,000
(c) (98,000 + 41,000 − 23,000)
2. Statement of Cash FlowsIndirect Method
Pioma Plastics Company

For the Year Ended April 30, 20X3
Gain on Sale of Land (63,000)
Loss on Sale of Plant 38,000
Increase in Debtors (1,12,000)
Decrease in Creditors (1,36,000)
Dividend Income (20,000)
Decrease in Prepaid Expenses 3,000
Decrease in Bills Payable (44,000)
Total Adjustments 3,63,000
Net Cash Used in Operating Activities (2,45,000)
Cash flows from Investing Activities
Proceeds from Sale of Land 1,33,000
Net Cash Provided by Investing Activities 1,73,000
Cash and Cash Equivalent at Beginning of Period 1,33,000
company purchased machinery for Rs 78,000 in exchange for secured debentures.
3. The statement of cash flows reveals a net cash outflow from operations of Rs 2,45,000,
where as the profit and loss account shows a net profit of Rs 1,18,000. Sharp increases in
debtors and inventory, coupled with sharp decreases in creditors and bills payable,
contributed to the cash deficit from operations. Further, a net gain of Rs 25,000 from
disposal of assets appears in the profit and loss account, but is excluded from cash flows
from operating activities in the statement of cash flows. There is a net inflow of Rs
1,95,000 from investing and financing operating activities. In sum, Pioma Plastics
Company used more cash in operations than all of the cash it received from its investing
and financing activities, resulting in a net decrease in cash.
Problem A-5: Preparing and Interpreting the Statement of Cash Flows
1. Statement Cash FlowsDirect Method
Arun Music Company

For the Year Ended October 31, 20X5
Income Tax Paid (c) (29,000)
Net Cash Used in Operating Activities Rs 5,000
Purchase of Plant and Machinery Rs (1,99,000)
Net Cash Used in Investing Activities (42,000)
Redemption of Secured Debentures (6,000)
Repayment of Unsecured Loans (41,000)

company purchased machinery for Rs 55,000 on long-term, unsecured credit.
(a) (9,27,000 + 61,000 − 1,27,000 − 21,000)

(b) (7,51,000 + 1,45,000 − 1,64,000 − 15,000 + 27,000 + 21,000 + 2,13,000 + 24,000 −
39,000 − 64,000 − 61,000 − 32,000
(c) (19,000 + 19,000 − 9,000)
Arun Music Company

For the Year Ended October 31, 20X5
Gain on Sale of Plant (23,000)
Increase in Bills Payable 12,000
Total Adjustments (24,000)
Net Cash Used in Operating Activities 5,000
3. The statement of cash flows reveals a net cash inflow from operations of Rs 5,000,
whereas the profit and loss account shows a net profit of Rs 29,000. There were sizeable
additions to debtors and inventory, but creditors and bills payable decreased. Further, a
gain of Rs 9,000 (net) from disposal of assets appears in the profit and loss account, but is
excluded from cash flows. The outflow of Rs 42,000 from investing and financing
activities exceeded the net inflow from operating activities. In sum, Arun Music Company
used more cash in its investing activities than all of the cash it received from its operating
and financing activities, resulting in a decrease in cash.
PROBLEM SET B
Problem B-1: Classification of Activities
a. Operating activity. g. None of the m. None of the s. Financing activity.

above. above.
b. Operating activity. h. Investing activity. n. Investing activity. t. Investing activity.
c. Non-cash activity. i. Non-cash activity. o. Non-cash activity. u. Investing activity.
d. Operating activity. j. Investing activity. p. Financing activity.
e. Financing activity. k. Financing activity. q. None of the
above.
f. Financing activity. l. Non-cash activity. r. Operating activity.
Problem B-2: Cash Flows from Operating Activities
1. Cash Flows from Operating ActivitiesDirect Method
Shamsher Leather Company

For the Year Ended July 31, 20X8
Net Cash Provided by Operating Activities Rs 1,22,000
(1) (7,69,000 + 23,000 − 3,000).

(2) (5,83,000 + 27,000 + 15,000 + 16,000 − 7,000).
(3) (28,000 + 5,000).

2. Cash Flow from Operating ActivitiesIndirect Method
Shamsher Leather Company

Gain on Sale of Plant and Equipment (8,000)
Decrease in Debtors 20,000
Decrease in Income Tax Payable (5000)
Problem B-3: Cash Flow from Operating Activities
Saleem Steel Company

(1) (9,69,000 − 1,41,000 − 11,000)

(2) (7,69,000 + 55,000 − 1,18,000 + 49,000 + 1,53,000 − 1,34,000 − 13,000)
(3) (76,000 − 29,000)

Saleem Steel Company

Depreciation Expense Rs 1,34,000
Loss of Sale of Trademarks 72,000
Decrease in Inventory 1,18,000
Increase in Debtors (1,52,000)
Decrease in Creditors (1,53,000)
Interest Expense (23,000)
Increase in Income Tax Payable 29,000
Total Adjustments (1,52,000)
Problem B-4: Preparing and Interpreting the Statement of Cash Flows
Vinay Electronics Company

Insurance Proceeds Received 17,000
Purchase of Plant and Machinery (1,39,000)
Proceeds from Issuance of Share Capital 20,000
Proceeds from Issuance of Secured Debentures 1,50,000
Proceeds from Issuance of Unsecured Loans 1,10,000
Net Cash Provided by Financing Activities 1,78,000
Net Increase in Cash and Cash Equivalents 1,28,000
Cash and Cash equivalent at Beginning of Period 33,000
Cash and Cash Equivalents at End of Period 1,61,000
(a) (4,39,000 + 1,04,000 − 1,54,000 − 16,000)

(b) (3,84,000 + 75,000 − 1,37,000 − 16,000 + 15,000 + 1,12,000 + 79,000 + 19,000 − 47,000
− 71,000 − 21,000 − 22,000).
(c) ( 20,000 − 5,000).
Vinay Electronics Company

Net Profit Rs (48,000)
Loss on Sale of Patent 26,000
Increase in Bills Payable 32,000
Net Cash Used in Operating Activities 5,000
Proceeds from Issuance of Unsecured Loans 1,10,000
Net Increase in Cash and Cash Equivalents 1,28,000
3. The statement of cash flows reveals a net cash inflow from operations of Rs 5,000, though
the profit and loss account shows a net loss of Rs 48,000. It is strange for the company to
experience an increase in cash. But a careful analysis of the statement of cash flows shows
that cash increased as a result of the issuance of share capital, secured debentures and
unsecured loans, which together resulted in an inflow of Rs 2,42,000, net of loan payments.
When the net outflow of Rs 55,000 from investing activities is deducted, there is still a net
inflow of Rs 1,23,000. After considering the net inflow from operating activities of Rs
5,000, there is a net increase in cash of Rs 1,28,000. Thus, it is clear that the increase in
cash is due to issuance of equity and debt during the period.
Problem B-5: Preparing and Interpreting the Statement of Cash Flows
Cochin Marine Foods Company

Net Cash Used in Operating Activities Rs (71,000)
Purchase of Plant and Machinery (33,000)
Net Cash Provided by Investing Activities 34,000
Net Increase in Cash and Cash Equivalents 78,000
(a) (8,58,000 + 65,000 − 93,000).

(b) (8,61,000 + 1,12,000 − 71,000 − 12,000 + 86,000 + 76,000 + 5,000 − 1,18,000 − 45,000).
(c) (8,000 − 1,000).
Cochin Marine Foods Company

Net Profit Rs (1,56,000)
Loss on Sale of Plant and Machinery 11,000
Decrease in Prepaid Expenses 7,000
Net Cash Used in Operating Activities (71,000)
Net Cash Used in Investing Activities 34,000

3. The statement of cash flows reveals a net cash outflow from operations of Rs 71,000 and
the profit and loss account shows a net loss of Rs 1,56,000. It is strange for the company to
experience an increase in cash. But a careful analysis of the statement of cash flows shows
that cash increased as a result of the issuance of share capital, secured debentures and
unsecured loans, which together resulted in an inflow of Rs 1,62,000. The net outflow from
operating activities totalled Rs 71,000. After considering the net inflow from investing
activities of Rs 34,000, there is a net increase in cash of Rs 78,000. It is clear that the
increase in cash is due to the issuance of equity and debt during the period.
Business Decision Cases

I. RELIANCE STATIONERY COMPANY
Teaching Notes
Case Setting and Objectives
This case involves preparation of a statement of cash flows in a standard format and
interpreting the statement. The focus of the case is that an increase in cash at the year-end
does not imply that the operations are profitable.
Suggested Solution
1.
Reliance Stationery Company
For the year Ended March 31, 20X4
Cash Received from Customers Rs 2,89,600
Cash Paid to Suppliers and Employees (a) (2,74,400)
Purchase of Fixtures and Office Equipment (2,72,000)
Net Cash Used in Investing Activities (2,69,600)
Proceeds from Issuance of Share Capital 3,52,000
Repayment of Loans (8,000)
Supplemental Schedule of Non-cash Investing and Financing Activities: The company

purchased a delivery van for Rs 24,000 on long-term credit.

(a) (2,02,400 + 1,28,000 − 56,000)
2. The statement of cash flows shows that there is a net cash inflow of Rs 15,200 from
operations. The net cash outflow from investing activities of Rs 2,69,600 resulted mainly
from the purchase of fixtures and office equipment. The purchase was paid for from the
proceeds from issuance of share capital. The net increase in cash of Rs 87,200 comes
mainly from two sources: from operations and from issuance of share capital. The
operations of Reliance Stationery Company in the first year are profitable and the earnings
are represented in cash. But this does not mean that the increase in cash of Rs 87,200 came
entirely by way of cash flow from operating activities.
Therefore, Uday's assessment that the Reliance Stationery Company had a successful first
year is probably correct, although his assumption that all of the increase in cash came from
the company's operations is not correct.
II. ANTARIKSH MATERIALS COMPANY
Teaching Notes
This case illustrates the interpretation and use of the statement of cash flows in a lending
context.
1.
Antariksh Materials Company
For the year Ended June 30, 20X8 (in thousands)
Income Tax Paid (c) (4,30,00)
Net Cash Used in Operating Activities Rs (4,08,25)
Net Cash Provided by Investing Activities 21,00
Dividend Paid (3,12,75)
Net Decrease in Cash and Cash Equivalents 2,20,00
Cash and Cash Equivalents at the Beginning of the Period 2,90,00
Cash and Cash Equivalents at the End of the Period 70,00

(1) (29,00,00 + 5,40,00 − 9,54,25)
(2) (16,78,00 + 2,05,00 − 8,50,00 − 80,00 + 1,80,00 + 15,30,00 + 11,00 − 1,20,00 − 90,00)
(3) (4,20,00 + 50,00 − 40,00)
Supplemental Schedule of Non-cash Investing and Financing Activities: The company

purchased a plant costing Rs 1,90,00,000 in exchange for equity shares.
2. From the statement of cash flows, Antariksh Materials Company had a net outflow of Rs
4,08,25,000 from operating activities. In other words, the company did not generate any
cash from operations. Even then the company paid dividends of Rs 3,12,75,000 during the
period.
3. Though the Antariksh Materials Company earned a net profit of Rs 5,75,00,000 during the
year ended June 30, 20X8, it lost cash of Rs 4,08,25,000 in its operations during the period.
A study of the statement of cash flows shows that this resulted mainly from the large
additions to inventory (Rs 6,80,00,000) and debtors (Rs 4,14,25,000). In spite of losing
cash in operations, the company went ahead with paying a dividend of Rs 3,12,75,000,
adding to its cash flow problems. It is clear from the statement of cash flows that the
dividend could not have been disbursed had the company not borrowed cash to pay
dividends. This is imprudent because dividends are supposed to be paid from profits
represented by cash. What the company has done can be labelled as bad financial
management.
Coming to the company's investment plans, it needs about Rs 10 crore. If its performance
during the year ended June 30, 20X8 is any indication, the company is unlikely to generate
significant positive cash flow from operations in 20X9. Therefore, the entire finance will
have to come from borrowings (at this time, the prospects for an equity issue do not seem
to be too bright). Even though its current level of borrowings is not unreasonable, the
company may not be much successful in raising additional loans if it continues to lose cash
in its operations. Also, the planned expansion in operations will require additional working
capital.
In these circumstances, the company's investments plans appear to be over ambitious, What
the company needs to do first is to manage its inventory and debtors more efficiently by
reviewing its policies and practices in these areas. A bank lending officer will not be
justified in recommending the loan at this stage.
Interpreting Financial Reports

I. NATIONAL THERMAL POWER CORPORATION
Teaching Notes
This case looks at a certain action taken by a power generation company to collect the
amounts receivable from its customer, a state electricity board (SEB) that has had difficulty
in paying its dues on time. The case examines whether the action would have the expected
results for NTPC. The case is significant in the context of the current debate on reforming the
energy industry in India.
The case illustrates accounting practices purely for the purpose of classroom discussions and
should not be taken as a judgement on the practices followed by the organisations that are
featured in the case.
Suggested Solution
1. The swap of the power plant for unpaid bills reduces the total dues of NTPC, as the
following entry shows:
Plant and Machinery (Power plant) 546,00,00,000

Debtors 546,00,00,000
2. The swap will not be reflected in NTPC's statement of cash flows because it does not
involve cash receipt. However, NTPC might like to mention the deal in the supplemental
schedule.
One effect of the plant-for-dues swap is the loss of cash inflow from UPSEB that might
have paid at least a part of the dues in the near future. Of course, NTPC could be assumed
to have considered the probability of that happening before agreeing to the deal. Also,
NTPC will end up paying the fuel, salaries and other expenses of the plant after it has been
taken over. But the electricity generated by the plant will have to be sold to the UPSEB for
logistical as well as political reasons. It is not clear how the UPSEB plans to pay for the
additional electricity purchased from NTPC, particularly when it has not been able to pay
for its existing purchases. It is likely that the deal will not improve NTPC's cash flow and
will end up further straining its cash flow. Furthermore, other SEBs may come up with
offers of plant-for-dues swap and NTPC would be stuck with uneconomical and inefficient
power plants and a workforce that does not meet NTPC's expectations, while being unable
to recover current and incremental dues for a long time to come. Eventually, NTPC could
very well end up in the unenviable position of having to face the problems that affect the
functioning of SEBs. In other words, the deal will spread to NTPC the malaise that affects
SEBs rather than solve it.
3. NTPC's main problem was that it was not able to collect its receivables from SEBs. Much
of the billings ended up increasing the year-end balance of debtors rather than getting
converted into cash. As a result, there was a wide gap between its accrual-based profit and
cash flow from operating activities.
NTPC has the following options:
i. Stop sale of power to defaulting SEBs and redirect the power to the SEBs that pay on
time. This may not be feasible for logistical as well as political reasons.
ii. Insist on advance payments or a revolving letter of credit from defaulting SEBs.
iii. Sell or securitise its receivables at a discount, likely to be considerable.
iv. Employ collection agents. This may not help much because the problem of non-payment
has to do with the SEBs' inability, not reluctance, to pay.

v. Ask the Central Government to divert its Plan allocations to the States concerned to
NTPC in settlement of the dues of the SEBs of the respective States.
The ICAI's AS 9 Revenue Recognition states that it may be more appropriate to recognise
revenue only when it is reasonably certain that the ultimate collection will be made. In the
case of SEBs' dues while there is no uncertainty about the ultimate collection of the amounts
because the SEBs are government organisations and will eventually pay, considerable delay
is likely given the financial position of these organisations. So the question whether NTPC
was proper in recognising the dues as revenues cannot be answered categorically.
II. STEEL AUTHORITY OF INDIA LIMITED
Teaching Notes
This case examines the reconciliation of net profit and cash flow from operating activities.
Many users of financial statements are puzzled when a company reports a loss, yet has a
positive cash flow from operating activities. By reviewing on the fundamentals of accrual
accounting and the cash flow statement, this case can help in understanding how such a
situation is not impossible. The items that explain the difference between the two can tell us a
lot about a company’s earnings quality. Also, the cash flow statement can provide insights
into how a company manages its finances.
The case illustrates accounting practices purely for the purpose of classroom discussions and
should not be taken as a judgement on the practices followed by the organisations that are
featured in the case.
Suggested Solution
1. It is possible for an enterprise to have a positive cash flow from operating activities despite
a net loss. The difference can be due to one or more of the following reasons (amounts are in
crores of rupees):
Net profit or net loss is calculated using accrual accounting, whereas cash flow from
operating activities is determined on the cash receipts and cash payments. Some
accrual items, such as depreciation expense, do not involve cash flow. SAIL has the
following non-cash items:
o depreciation, Rs 1164.12;
o provision for diminution in value of assets, Rs 0.02;
o bad debt expenses written off, Rs 7.08;
o deferred revenue expenditure, Rs 232.54.
Items of gains and losses that do not pertain to operating activities are excluded from
net profit or net loss to determine cash flow from operating activities. An example is
profit on sale of assets. SAIL has the following items of this kind:

o profit on sale of fixed assets, Rs 662.47;
o interest expenses, Rs 1562.03;
o interest income, Rs 105.30;
o dividend income, Rs 5.74.
Cash flow from operating activities is determined after adjusting net profit or net loss
for changes in current assets and current liabilities. For example, increase in
inventories does not affect the profit and loss account in accordance but it is treated as
a cash flow. In the case of SAIL, we find the following items:
o decrease in inventories, Rs 477.16;

o decrease in debtors, Rs 291.10;
o decrease in loans and advances, Rs 138.53;
o increase in current liabilities and provisions, Rs 132.96;
o deferred charges incurred during the year but not expensed, Rs 438.20;
2. The company's cash came from operating activities and, to a lesser extent, reduction of
cash and cash equivalents. The major uses of cash were payment of interest and finance
charges and repayment of borrowings. There was net inflow from investing activities which
suggests that the company sold more assets than it acquired. While the company incurred a
net loss in 2001-2002, it managed pay its obligations. The high level of borrowings was
responsible for the huge interest payment which hurt the company in a bad year. This raises
the question whether the company had excessive debt. Also, we should remember that the
steel industry is cyclical and this year might have been the bottom of the cycle. To confirm
this we should look at the performance of other steel companies in the year. In part, the
company managed its problem by selling of (conceivably excess or spare) assets.
3. From the profit and loss account and the cash flow statement, it appears that there were
many one-time or non operating items that raise questions about the company's quality of
earnings. These include the following:
o profit on sale of fixed assets, Rs 662.47 that is much higher than in the previous
year (this item is probably included in other revenues in the profit and loss
account);
o provision no longer required written back that is higher than in the previous year;
o a large addition to deferred revenue expenditure that is carried on the balance
sheet.

Solman 12 Second Ed

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CHAPTER 12

STATEMENT OF CASH FLOWS

Financing activities: Proceeds from issuing equity instruments and payment of

8. Possible sources of the difference include: increase in debtors, increase in inventory,

a. A cash outflow from financing activities.

10. Adjustment of items:

a. Add to net profit.

13. Possible reasons include: increase in debtors , increase in inventory, decrease in

p.2 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Exercise 12.2: Classification of Activities

a. None of the above. e. Operating activity. i. Non cash activity. m. Operating

Exercise 12.3: Determining Net Cash Flow from Operating Activities

(1) (25,000 + 4,36,000 + 78,000 − 49,000 − 16,000).

Exercise 12.4: Determining Net Cash Flow from Operating Activities

Exercise 12.5: Determining Net Cash Flow from operating Activities

(1) (7,29,000 + 92,000 − 97,000 − 4,000).

p.4 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Exercise 12.8: Determining Net Cash Flow from Financing Activities

Item e is a non cash transaction to be shown in a supplement schedule.

Exercise 12.9: Preparing the Statement of Cash Flows

(1) 9,73,000 + 1,56,000 − 2,09,000 = 9,20,000

a. Operating activity. g. Non cash activity. m. Investing activity. s. Operating activity.

Problem A-2: Cash Flow from Operating Activities

1. Cash Flow from Operating Activities-Direct Method

Gopal Dairy Company

(1) (2,71,000 − 12,000 − 2,000).

p.6 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Gopal Dairy Company

Problem A-3: Cash Flow from Operating Activities

1. Cash Flow from Operating Activities-Indirect Method

(1) (9,28,000 + 46,000 − 7,000).

Statement of Cash Flows  Chapter 12 p.7

Problem A-4: Preparing and Interpreting the Statement of Cash Flows

1. Statement Cash Flows-Direct Method

Pioma Plastics Company

(a) (7,58,000 + 1,18,000 − 2,16,000 − 14,000)

2. Statement of Cash FlowsIndirect Method

Pioma Plastics Company

Problem A-5: Preparing and Interpreting the Statement of Cash Flows

1. Statement Cash FlowsDirect Method

Arun Music Company

p.10 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

(a) (9,27,000 + 61,000 − 1,27,000 − 21,000)

2. Statement of Cash FlowsIndirect Method

Arun Music Company

a. Operating activity. g. None of the m. None of the s. Financing activity.

Problem B-2: Cash Flows from Operating Activities

1. Cash Flows from Operating ActivitiesDirect Method

Shamsher Leather Company

(1) (7,69,000 + 23,000 − 3,000).

p.12 Instructor's Manual to Accompany Financial Accounting: A Managerial Perspective 2/e

Shamsher Leather Company

Problem B-3: Cash Flow from Operating Activities

1. Cash Flow from Operating ActivitiesIndirect Method

Saleem Steel Company

(1) (9,69,000 − 1,41,000 − 11,000)

Statement of Cash Flows  Chapter 12 p.13

Saleem Steel Company

Problem B-4: Preparing and Interpreting the Statement of Cash Flows

1. Statement Cash FlowsDirect Method

Vinay Electronics Company

(a) (4,39,000 + 1,04,000 − 1,54,000 − 16,000)

2. Statement of Cash FlowsIndirect Method