CFA Level 1 (2009) - 3

Study Session 8 Cross-Reference to CFA Institute Assigned Reading #34 - Understanding the Cash Flow Statement

I.Using the following information, what is {he firm"s cash flow from operations?

Use the following data to answer Questions 2 through 4.

Study Session R

Cross-Referencc to CFA Institute Assigned Reading #34 - Understanding thc Cash Flow Statemcnt

3.The cash flow from investing activities is:

A. -$30.

13. $20. e. 50.

4.The cash flow fromfiml1lcing aetillities is:

A.$30.

B.$55.

c:.$75.

5.Given the following:

The cash flow from operations is:

A.$115.

B.$275. e. $375.

6.Which of the following items is Least LikeLy considered a cash flow from financing activity under U.S. GAAP?

A.Receipt of cash from the sale of bonds.

B.Payment of cash for dividends.

C.Payment of interest on debt.

7.Which of the following would be Least Likely ro cause a change in investing cash flow?

A.The sale of a division of the company.

B.The purchase of new machinery.

C.An increase in depreciation expense.

8.Which of the following is Least LikeLy a change in cash flow from operations under U.S. GAAP?

A.A decrease in notes payable.

B.An increase in interest expense.

C. An increase in accounts payable.

Study Session 8 Cross-Reference to CFA Institute Assigned Reading #34 - Understanding the Cash How Statement

9.Where are dividends paid to shareholders reponed in the cash Aow statemcm under U.S. GAAP and IFRS?

U.S. CAAP

A. Operating or financing acrivities B. Financing activities

c:. 0rcrating acrivities

I D. Sales of inventory would be classifIed as:

A.operating cash Aow.

B.investing cash Aow. e. financing cash flow.

11. Issuing bonds would be classified as:

A.investing cash How.

B.financing cash flow.

e:. no cash flow impact.

12.Sale of land would be classified as:

A.operating CJsh How.

B.investing cash How.

e.fi nancing cash flow.

13.An increase in taxes payable would be classified as:

A.operating cash flow.

B.financing cash flow.

e.no cash flow impace.

14.An increase in notes payahle would be classified as:

A.investing cash Aow.

B.financing cash flow.

e:. no cash flow impact.

15.Under U.S. GAAP, an increase in interest payable would be classified as:

A.operating cash flow.

B.financing cash flow.

e.no cash flow impact.

16.Under U.S. GAAP, an increase in dividends payable would be classified as:

A.operating cash flow.

B.investing cash flow.

e.financing cash flow.

17.The write-off of obsolete equipment would be classified as:

A.operating cash flow.

B.investing cash flow. e. no cash flow impact.

18.Sale of obsolete equipmem would be classified as:

A.operating cash flow.

B.investing cash flow.

e. financing cash flow.

Study Session 8

Cross-Reference to CFA Institute Assigned Reading #34 - Understanding the Cash Flow Statement

19.Under IFRS, iIHerest expense woulJ be classified as:

A.either operating cash How or fin;lI1cing cash flow.

B.operating cash flow only. e. financing cash flow only.

20.Depreciation expense would be classified as:

A.operating cash How.

B.investing cash How.

e.no cash flow impact.

21.Under U.S. GAAP, dividends received from investments would be classified as:

A.operating cash flow.

B.investing cash flow.

e.f1nancing cash How.

22.Torval Inc. retires debt securities by issuing equity securities. This is considered a:

A.cash Bow from investing.

B.cash flow from financing.

C.noncash transaction.

23.Net income for Monique Inc. for the year ended December 31, 20X7 was

$78,000. Jts accounts receivable balance at December 31, 20X7 was $121,000, and this balance was $69,000 at December 31, 20X6. The accounts payable balance at December 31, 20X7 was $72,000 and was $43,000 at December 31, 20X6. Depreciation for 20X7 was $12,000, and there was an unrealized gain of $15,000 included in 20X7 income from the change in value of trading

securities. Which of the following amounts represents Monique's cash flow from operations for 20X7?

A.$52,000.

B.$67,000.

C. $82,000.

24.Martin Inc. had the following transactions during 20X7:

• Purchased new fixed assets for $75,000.

• Converted $70,000 worth of preferred shares to common shares.

•Received cash dividends of$12,000. Paid cash dividends of$21,OOO.

•Repaid mortgage principal of $17,000.

Assuming Martin follows U.S. GAAP, which of the following amounts represents Martin's cash flows from investing and cash flows from financing in 20X7, respectively?

Cash flows from investing

A. ($5,000)

B. ($75,000)

C. ($75,000)

Stlldy Session 8 Cross-Reference to CFA Institute Assigned Reading #34 - Understanding the Cash Flow Statement

C. the change in cash.

Notes:

Dividends declared to shareholders were $10.

•New common shares were sold at par for $30,

Fixed assets were sold for $30. Original cost of these assets was $80, and $(;0 of accumulated depreciation has been charged to their original cost.

•The firm borrowed $100 on a 10-year bank note-the proceeds of the loan were

llSed lO pay for new fixed assets.

•Depreciation for the year was $100 (JccIlJnIl!atcd depreciation up $40 and depreciation on sold asscts $60),

Study Session 8

Cross-Reference co CFA Institure Assigned Reading #34 - Understanding the Cash Flow Statement

A.Calculate cash How from operations, using the indirect medlOd.

B.Calculatc lOtal cash colleerions, cash paid [0 supplicrs, and othcr cash cxpenses.

c. Calculate cash How from opcr:Hions using the direct mcthod.

D.Calculate cash How from financing, cash How from investing, and wtal cash How.

E.Calculate frce cash flow to equity owncrs.

F.What would the impact on investing cash How and. financing cash flow have been jf thc company leased the new fixed assets instead of borrowing the money and purchasing the equipmel1[?

Study Session 8 Cross-Reference to CFA Institute Assigned Reading #34 - Understanding the Cash Flow Statement

1. B Net inco!lle - profits {'rom sale o{' land + dqHLl:iarion ~ decrease in ITLeivables· tncrease

in inventories + increase in acCOlllHS payable - decrease in wages payable + increase in deferred tax liabilities ~ 120 - 2 + 25 + 2010 + 7 -- 5 + 15 = $170. Note that

the profit on lhe sale of' land should be SublLIClnl ('rom net income to avoid douhle counting the gain in net income and investing aClivilies.

2.B Net income - profit on sale of building + depreciation = 45 - 20 + 75 = $100. Note that taxes and interest are already deducted in calculating net income, and that the profit on the sale of the building should be subtracted from net income.

7.C Depreciation docs not represent a cash flow. To the extent that it affects the firm's taxes, an increase in depreciation changes operating cash flows, but not investing cash flows.

8.A A change in notes payable is a financing cash flow.

9.B Under U.S. GAAP, dividends paid are reponed as financing activities. Under IFRS, dividends paid can be reponed as either operating or financing activities.

10. A Sales of inventory would be classified as operating cash How.

I\. B Issuing bonds would be classified as financing cash flow.

12.B Sale of land would be classified as investing cash flow.

13.A Increase in taxes payable would be classified as operating cash flow.

14.B Increase in notes payable would be classified as financing cash flow.

15.A Increase in interest payable would be classified as operating cash flow under U.S. GAAP.

1G. C Increase in dividends payable would be classified as financing cash flow under U.S.

GAAP.

17.C Write-off of obsolete equipment has no cash How impact.

18.B Sale of obsolete equipment would be classified as investing cash flow.

19.A Under IFRS, interest expense can be classified as either an operating cash flow or financing cash How.

Study Session H

Cross-Refercncc to Cl-'A Institute Assigncd Rcading #34 - Understanding thc Cash Flow Statcmcnt

20. C Depreciation expense would be classified as no cash How impacL

21.• A Dividends received from invl's[l'nents would be classifi,·d as opnating cash How under U.S. CAAP.

22. C Tile excilange of debt securities ror elJuity securities is a noncasll lransaetiou.

21.C l'urchased new fixed assets for S75,OOO _. cash .t2.l!.dl(),,\' from investing <":onvLrted Si70,OOO of prderr"d shares to common shares .. nuncash transactiun Received dividends of $12,000cash inHu\V from opnalium

Paid dividends uf $21,000cash 'l.m(Jm'C from financing i'vlongage repavn1l'nt of $17.000 - ca,h ()lllil,)\\' frun\ financing

<:Fl· ·7'S,O()0

<:IF'"-21 ,OO()- ] 7,000 =·$JH,O()()

25. B The cash flow statcmCI1l can be converted to common-sizc formal b)' expressing each line item as a percentage of revenue.

A.Nct income - gain on sale of l11achint:ry -I deprecialion - innease in receivables + decrease in inventories -I increase in accounts payable -I increJse in inlere'l p:lyable c

GO - 10 -I 100 - 50 -I GO -I 20 + 5 = $185.

B.C:lsh collections = sales - increase in receivables = 1,425 - 50 = $1,375.

D.CFF = sale of stock + new bank note - payment of mortgage - dividends + increase in

Study Scssion H

Cross-Reference to Cf'1\ Institute Assigned Reading #34 - Understanding the Cash Flow Statelllcnt

'rhe easiesl welY to determine lOlal cash flow is lO simply lake lhe change in cash [rom lhClbabnce sheer. llowevn, adding the three COll1pOnelllS of cash flow will yield

185 -70, 75c $190.

FInvesting cash flow would be higher and financing cash flow would be lower. The company would spend less on investments bUl would not havl' inflows from lhl' borrowing.

____________________________,.,M*NrinP'S....... ~

The following is a review of the Financial Reporting and Analysis principles designed to address the learning outcome statements set forth by erA lllstitute@. This topic is also covered in:

INVENTORIES

Study Session 9

EXAM Focus

Metchandising firms, such as wholesalers and retailers, purchase inventory that is ready for sale. In this case, inventory is reported in one account on the balance sheet. On

the other hand, manufacturing firms normally report inventory using three separate accounts: raw materials, work-in-process, and finished goods.

The choice of inventory cost flow method affects the firm's income statement, balance sheet, and several important financial ratios. Additionally, the cost flow method can affect the firm's income taxes and, thus, the firm's cash flow.

The inventory cost flow method should not be confused with the inventory valuation method as required by IFRS and U.S. GAAP. Generally, inventory is reported on

the balance sheet at cost and a writedown (loss) is recognized if the market value of inventory declines below cost. The valuation method (lower of cost or net realizable value for firms reporting under IFRS, and lower of cost or market for firms reporting under U.S. GAAP) is applied regardless of the cost flow method.

Cost of goods sold is related to the beginning balance of inventory, purchases, and the ending balance of inventory. The relationship is summarized in the following equation:

COGS = beginning inventory + purchases - ending inventory

This equation can be rearranged to solve for any of the four variables:

Purchases = ending inventory - beginning inventory + COGS

Beginning inventory = COGS - purchases + ending inventory

Ending inventory = beginning inventory + purchases - COGS