Chapter 11: Financial Statements of Companies - Test 4: answer key

Question 1 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Scenario. Nivara Auto Components Ltd. is a non-financial company. The following information relates to the year ended 31 March 2026. The company's profit before tax of ₹520 lakh includes depreciation of ₹70 lakh, goodwill amortisation of ₹10 lakh and debenture interest expense of ₹24 lakh. It also includes a loss on sale of machinery of ₹12 lakh and a profit on sale of investments of ₹18 lakh. During the year, inventories decreased by ₹30 lakh, trade receivables increased by ₹45 lakh, prepaid operating expenses decreased by ₹5 lakh, trade payables decreased by ₹20 lakh and outstanding operating expenses increased by ₹8 lakh. Income tax of ₹95 lakh was paid during the year. Interest paid on debentures was ₹20 lakh. The following investing cash flows also occurred: machinery sold for ₹25 lakh; plant purchased for ₹160 lakh; investments sold for ₹50 lakh; investment made in a subsidiary for ₹45 lakh; and interest received on investments of ₹6 lakh. Financing cash flows comprised issue of equity shares for ₹100 lakh, proceeds from long-term borrowings of ₹75 lakh, repayment of bank borrowings of ₹40 lakh, interest paid of ₹20 lakh and dividend paid of ₹30 lakh. Opening cash and cash equivalents were ₹75 lakh. Prepare the relevant cash flow computations using the indirect method.

What is the operating profit before working capital changes under the indirect method?

1. ₹606 lakh
2. ₹594 lakh
3. ₹618 lakh (correct answer)
4. ₹642 lakh

Answer: C — ₹618 lakh

Explanation. Start with profit before tax of ₹520 lakh. Add back non-cash and financing expenses: depreciation ₹70 lakh, loss on sale of machinery ₹12 lakh, goodwill amortisation ₹10 lakh and debenture interest expense ₹24 lakh. Deduct the profit on sale of investments of ₹18 lakh because it relates to an investing activity. Operating profit before working capital changes is ₹520 + ₹70 + ₹12 + ₹10 + ₹24 - ₹18 = ₹618 lakh.

Where it goes wrong. Do not add the profit on sale of investments to operating profit. It is deducted from the indirect-method computation because the related sale proceeds are considered under investing activities.

Authority. AS 3, para 21; Chapter 11, Unit 2.4.2 - Indirect Method

Question 2 · 2 marks · Chapter 11: Financial Statements of Companies · hard

What is the net effect of the stated working capital changes on cash generated from operations?

1. Decrease of ₹22 lakh (correct answer)
2. Increase of ₹22 lakh
3. Decrease of ₹62 lakh
4. Increase of ₹62 lakh

Answer: A — Decrease of ₹22 lakh

Explanation. A decrease in inventory increases cash by ₹30 lakh. An increase in trade receivables reduces cash by ₹45 lakh. A decrease in prepaid operating expenses increases cash by ₹5 lakh. A decrease in trade payables reduces cash by ₹20 lakh, while an increase in outstanding operating expenses increases cash by ₹8 lakh. The net effect is ₹30 - ₹45 + ₹5 - ₹20 + ₹8 = negative ₹22 lakh.

Where it goes wrong. Apply the working capital rule separately to each balance. Increases in operating current assets generally reduce cash, whereas increases in operating current liabilities generally increase cash.

Authority. AS 3, para 21; Chapter 11, Unit 2.4.2 - Indirect Method

Question 3 · 2 marks · Chapter 11: Financial Statements of Companies · hard

After incorporating the working capital changes and income tax paid, what is the net cash generated from operating activities?

1. ₹596 lakh
2. ₹523 lakh
3. ₹479 lakh
4. ₹501 lakh (correct answer)

Answer: D — ₹501 lakh

Explanation. Operating profit before working capital changes is ₹618 lakh. The net working capital adjustment is a decrease of ₹22 lakh, resulting in cash generated from operations of ₹596 lakh. Deduct income tax paid of ₹95 lakh to arrive at net cash generated from operating activities of ₹501 lakh. Interest paid is presented under financing activities for this non-financial company in accordance with the treatment used in the chapter illustration.

Where it goes wrong. ₹596 lakh is cash generated from operations before income tax, not net cash from operating activities after tax. Also, do not deduct interest paid again from operating activities when it is separately shown under financing activities.

Authority. AS 3, para 21; AS 3, para 34; Chapter 11, Unit 2.4.2 - Indirect Method

Question 4 · 2 marks · Chapter 11: Financial Statements of Companies · hard

What is the closing balance of cash and cash equivalents at 31 March 2026?

1. ₹462 lakh
2. ₹537 lakh (correct answer)
3. ₹612 lakh
4. ₹499 lakh

Answer: B — ₹537 lakh

Explanation. Net cash from operating activities is ₹501 lakh. Net investing cash flow is ₹25 + ₹50 + ₹6 - ₹160 - ₹45 = negative ₹124 lakh. Net financing cash flow is ₹100 + ₹75 - ₹40 - ₹20 - ₹30 = ₹85 lakh. The net increase in cash is ₹501 - ₹124 + ₹85 = ₹462 lakh. Adding opening cash and cash equivalents of ₹75 lakh gives closing cash and cash equivalents of ₹537 lakh.

Where it goes wrong. The net increase of ₹462 lakh is not the closing balance. Add the opening cash and cash equivalents balance to obtain the closing figure.

Authority. AS 3, paras 15, 17 and 21; Chapter 11, Unit 2.5 and Unit 2.6

Question 5 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. Delta Textiles Ltd. uses the direct method to report cash flows from operating activities. For the year ended 31 March 2026, total sales were ₹1,500 lakh, of which 40% were cash sales and the balance were credit sales. Trade receivables stood at ₹260 lakh at the beginning and ₹310 lakh at the end of the year. Total purchases were ₹700 lakh, of which 70% were credit purchases and 30% were cash purchases. Trade payables stood at ₹180 lakh at the beginning and ₹225 lakh at the end of the year. Cash paid to employees was ₹180 lakh, cash paid for other operating overheads was ₹110 lakh and income tax paid was ₹70 lakh. During the year, the company acquired a new plant costing ₹80 lakh by exchanging old machinery having a book value of ₹45 lakh and paying the balance amount in cash. Consider these facts while answering the questions relating to the direct method and the cash treatment of the plant acquisition.

What amount should Delta Textiles Ltd. report as cash receipts from customers under the direct method?

1. ₹1,450 lakh (correct answer)
2. ₹1,390 lakh
3. ₹1,550 lakh
4. ₹1,400 lakh

Answer: A — ₹1,450 lakh

Explanation. Cash sales are 40% of ₹1,500 lakh, amounting to ₹600 lakh. Credit sales are ₹900 lakh. Cash collected from credit customers is opening trade receivables plus credit sales less closing trade receivables, i.e. ₹260 + ₹900 - ₹310 = ₹850 lakh. Total cash receipts from customers are ₹600 + ₹850 = ₹1,450 lakh.

Where it goes wrong. Do not treat total sales as cash receipts. Adjust credit sales for the movement in trade receivables and add cash sales separately.

Authority. AS 3, paras 18 and 20; Chapter 11, Unit 2.4.1 - Direct Method

Question 6 · 2 marks · Chapter 11: Financial Statements of Companies · hard

What is the total cash payment to suppliers for the year?

1. ₹445 lakh
2. ₹625 lakh
3. ₹655 lakh (correct answer)
4. ₹700 lakh

Answer: C — ₹655 lakh

Explanation. Credit purchases are 70% of ₹700 lakh, i.e. ₹490 lakh, and cash purchases are ₹210 lakh. Cash paid against credit purchases is opening trade payables plus credit purchases less closing trade payables: ₹180 + ₹490 - ₹225 = ₹445 lakh. Add cash purchases of ₹210 lakh. Total cash payments to suppliers are ₹655 lakh.

Where it goes wrong. ₹445 lakh represents payments against credit purchases only. Cash purchases must also be included to arrive at total supplier payments.

Authority. AS 3, paras 18 and 20; Chapter 11, Unit 2.4.1 - Direct Method

Question 7 · 2 marks · Chapter 11: Financial Statements of Companies · hard

What is the net cash generated from operating activities under the direct method?

1. ₹505 lakh
2. ₹435 lakh (correct answer)
3. ₹375 lakh
4. ₹455 lakh

Answer: B — ₹435 lakh

Explanation. Cash receipts from customers are ₹1,450 lakh. Deduct supplier payments of ₹655 lakh, employee payments of ₹180 lakh and other operating overhead payments of ₹110 lakh. Cash generated from operations is ₹505 lakh. After deducting income tax paid of ₹70 lakh, net cash generated from operating activities is ₹435 lakh.

Where it goes wrong. ₹505 lakh is the amount before income tax. The question asks for net cash from operating activities, so income tax paid must also be deducted.

Authority. AS 3, paras 18 and 20; Chapter 11, Unit 2.4.1 - Direct Method

Question 8 · 2 marks · Chapter 11: Financial Statements of Companies · hard

The new plant cost ₹80 lakh and was acquired by exchanging old machinery with a book value of ₹45 lakh and paying the balance in cash. What amount should be shown as the cash outflow for purchase of plant in the investing activities section?

1. ₹80 lakh
2. ₹45 lakh
3. Nil
4. ₹35 lakh (correct answer)

Answer: D — ₹35 lakh

Explanation. The new plant costs ₹80 lakh, of which ₹45 lakh is settled through exchange of old machinery and ₹35 lakh is paid in cash. Only the cash component of ₹35 lakh is included as an investing cash outflow in the cash flow statement. The non-cash exchange component is disclosed separately so that the significant investing transaction is not omitted from the financial statement disclosures.

Where it goes wrong. Showing the full ₹80 lakh as a cash outflow incorrectly treats the non-cash exchange as cash paid. Showing only ₹45 lakh would also be incorrect because that is the book value of the machinery exchanged, not the cash paid.

Authority. AS 3, paras 15 and 40; Chapter 11, Illustration 11 - Significant non-cash items

Question 9 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. Aster Industries Ltd. is a non-financial company. During the year ended 31 March 2026, it advanced a loan of ₹20 lakh to its subsidiary and received repayment of ₹7 lakh from an unrelated entity against a loan previously advanced to it. It purchased equity shares of another company for ₹12 lakh and sold debt instruments of another entity for ₹5 lakh. It received interest of ₹3 lakh on investments and dividend of ₹2 lakh from its subsidiary. Tax deducted at source on the interest received from investments was ₹0.30 lakh. The company also received an insurance claim of ₹6 lakh for the loss of a fixed asset due to fire. Financing transactions comprised issue of equity shares for ₹16 lakh, proceeds from debentures of ₹9 lakh, repayment of bank loan of ₹8 lakh, interest paid on debentures of ₹4 lakh and dividend paid of ₹5 lakh. Separately, the company had paid TDS of ₹0.20 lakh on interest earned on an advance given to a supplier. Apply the classifications and presentation principles explained in AS 3.

How should the two TDS payments be classified: (i) TDS on interest earned on an advance given to a supplier, and (ii) TDS on interest earned on investments?

1. Both are financing cash outflows
2. The first is an operating cash outflow and the second is an investing cash outflow (correct answer)
3. The first is an investing cash outflow and the second is an operating cash outflow
4. Both are operating cash outflows

Answer: B — The first is an operating cash outflow and the second is an investing cash outflow

Explanation. The chapter illustration classifies TDS on interest earned on an advance given to suppliers as an operating cash outflow because the underlying advance is related to operating activities. TDS on interest earned on investments is classified as an investing cash outflow because the related investment income is treated as an investing cash flow for the non-financial company.

Where it goes wrong. Do not classify both TDS payments merely by their common tax-deduction label. The classification follows the nature of the underlying interest receipt and the related activity.

Authority. AS 3, paras 10–15; Chapter 11, Illustration 1(iv) and 1(v)

Question 10 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Including the insurance claim received for the loss of the fixed asset due to fire, what is the net cash flow from investing activities?

1. Negative ₹15.30 lakh
2. Positive ₹9.30 lakh
3. Negative ₹9.30 lakh (correct answer)
4. Positive ₹6.70 lakh

Answer: C — Negative ₹9.30 lakh

Explanation. Investing cash flows are: loan advanced to subsidiary ₹20 lakh outflow; repayment of loan by another party ₹7 lakh inflow; purchase of shares ₹12 lakh outflow; sale of debt instruments ₹5 lakh inflow; interest received ₹3 lakh inflow; dividend received ₹2 lakh inflow; TDS on investment interest ₹0.30 lakh outflow; and insurance claim ₹6 lakh inflow. Net investing cash flow is -₹20 + ₹7 - ₹12 + ₹5 + ₹3 + ₹2 - ₹0.30 + ₹6 = negative ₹9.30 lakh. The insurance claim is separately identified as an extraordinary-item cash inflow within investing activities.

Where it goes wrong. Do not omit the insurance claim from total investing cash flow merely because it is shown separately. Separate presentation does not change its classification as an investing cash inflow.

Authority. AS 3, paras 15 and 29; Chapter 11, Unit 2.3.2 and Illustration 1(vi)

Question 11 · 2 marks · Chapter 11: Financial Statements of Companies · medium

What is the net cash flow from financing activities of Aster Industries Ltd.?

1. Positive ₹8 lakh (correct answer)
2. Positive ₹12 lakh
3. Negative ₹8 lakh
4. Positive ₹21 lakh

Answer: A — Positive ₹8 lakh

Explanation. Financing inflows are proceeds from issue of equity shares of ₹16 lakh and proceeds from debentures of ₹9 lakh. Financing outflows are repayment of bank loan ₹8 lakh, interest paid on debentures ₹4 lakh and dividend paid ₹5 lakh. Net financing cash flow is ₹16 + ₹9 - ₹8 - ₹4 - ₹5 = positive ₹8 lakh.

Where it goes wrong. Do not include the loan repayment, interest paid or dividend paid as investing or operating items in this question. The chapter's non-financial-company illustrations present these specified payments under financing activities.

Authority. AS 3, para 17; Chapter 11, Unit 2.3.3 - Financing Activities

Question 12 · 2 marks · Chapter 11: Financial Statements of Companies · medium

How should the insurance claim of ₹6 lakh received for the loss of a fixed asset due to fire be presented?

1. As ordinary operating revenue
2. As a financing cash inflow
3. It should be excluded because it is not a cash flow
4. As a separately disclosed extraordinary-item cash inflow from investing activities (correct answer)

Answer: D — As a separately disclosed extraordinary-item cash inflow from investing activities

Explanation. The chapter specifically illustrates an insurance claim received against the loss of a fixed asset by fire. It is presented under a separate heading as a cash inflow from investing activities, with separate disclosure as an extraordinary item. The separate presentation identifies the unusual nature of the receipt while retaining its investing classification.

Where it goes wrong. The fact that the receipt is unusual does not make it a financing activity or remove it from the cash flow statement. Its connection with the fixed asset determines its investing classification.

Authority. AS 3, para 29; Chapter 11, Illustration 1(vi)

Question 13 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. Which statement correctly describes the principal usefulness of a cash flow statement?

Which statement correctly describes the principal usefulness of a cash flow statement?

1. It replaces the statement of profit and loss for measuring profitability
2. It reports only cash generated from trading operations and excludes other cash movements
3. It provides information about historical changes in cash and cash equivalents to help users assess the enterprise's ability to generate cash, and the timing and certainty of those cash flows (correct answer)
4. It determines the market value of the enterprise's assets and liabilities

Answer: C — It provides information about historical changes in cash and cash equivalents to help users assess the enterprise's ability to generate cash, and the timing and certainty of those cash flows

Explanation. A cash flow statement provides information about historical changes in cash and cash equivalents. It helps users assess an enterprise's ability to generate cash and cash equivalents and evaluate the timing and certainty of their generation. The chapter also identifies its usefulness in assessing liquidity, quality of earnings and solvency.

Where it goes wrong. A cash flow statement does not replace the statement of profit and loss and does not directly measure market value. It complements the other financial statements by explaining cash movements.

Authority. AS 3, para 1; Chapter 11, Unit 2.1 - Introduction

Question 14 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. Which of the following descriptions correctly identifies cash equivalents under AS 3?

Which of the following descriptions correctly identifies cash equivalents under AS 3?

1. Short-term, highly liquid investments readily convertible into known amounts of cash and subject to an insignificant risk of changes in value (correct answer)
2. All investments that can be sold in the market within one year
3. All equity shares listed on a recognised stock exchange
4. All bank deposits, irrespective of their maturity and risk

Answer: A — Short-term, highly liquid investments readily convertible into known amounts of cash and subject to an insignificant risk of changes in value

Explanation. 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 changes in value. The chapter notes that securities with a short maturity period of, say, three months or less from the date of acquisition may qualify, subject to the other conditions.

Where it goes wrong. Liquidity or the ability to sell an investment within one year is not enough. The investment must also be readily convertible into a known amount of cash and carry an insignificant risk of changes in value.

Authority. AS 3, paras 5–7; Chapter 11, Unit 2.2 - Elements of Cash

Question 15 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Scenario. A company acquired a highly liquid fixed-income investment with an original maturity of six months. At the reporting date, only two months remain until maturity. Assuming the other cash-equivalent conditions are satisfied, how should the investment be treated?

A company acquired a highly liquid fixed-income investment with an original maturity of six months. At the reporting date, only two months remain until maturity. Assuming the other cash-equivalent conditions are satisfied, how should the investment be treated?

1. It qualifies because the remaining maturity is less than three months
2. It does not qualify on the stated maturity test because the relevant short maturity is considered from the date of acquisition (correct answer)
3. It qualifies automatically because it is highly liquid
4. It must be treated as cash in hand

Answer: B — It does not qualify on the stated maturity test because the relevant short maturity is considered from the date of acquisition

Explanation. The chapter states that a security normally qualifies as a cash equivalent only when it has a short maturity period of, say, three months or less from the date of acquisition. The investment was acquired with an original maturity of six months. The fact that only two months remain at the reporting date does not satisfy the stated acquisition-date maturity test.

Where it goes wrong. Do not measure the three-month period only by the remaining term at the balance sheet date. The chapter's wording refers to the maturity period from the date of acquisition.

Authority. AS 3, para 7; Chapter 11, Unit 2.2 - Elements of Cash

Question 16 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. A company transfers funds from its current bank account into a 60-day bank deposit that meets the definition of a cash equivalent. How is this transfer treated in the cash flow statement?

A company transfers funds from its current bank account into a 60-day bank deposit that meets the definition of a cash equivalent. How is this transfer treated in the cash flow statement?

1. As an investing cash outflow
2. As a financing cash outflow
3. As an operating cash outflow
4. It is excluded because it is a movement between components of cash and cash equivalents (correct answer)

Answer: D — It is excluded because it is a movement between components of cash and cash equivalents

Explanation. A cash flow statement does not consider movements among items that constitute cash and cash equivalents. Such movements are part of cash management rather than operating, investing or financing activities. The chapter gives examples such as cash withdrawn from a current account and cash deposited in a bank for 60 days, where the deposit qualifies as a cash equivalent.

Where it goes wrong. Do not classify every bank-account movement as a cash flow. First determine whether both the source and destination are components of cash and cash equivalents.

Authority. AS 3, para 9; Chapter 11, Unit 2.2 - Elements of Cash

Question 17 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Scenario. A stockbroking enterprise enters into forward contracts and buys and sells securities held for dealing or trading purposes. The resulting cash receipts and payments are generally classified under which activity?

A stockbroking enterprise enters into forward contracts and buys and sells securities held for dealing or trading purposes. The resulting cash receipts and payments are generally classified under which activity?

1. Investing activities in every case
2. Financing activities in every case
3. Operating activities (correct answer)
4. Non-cash activities

Answer: C — Operating activities

Explanation. The chapter identifies cash receipts and payments relating to futures, forward, option and swap contracts held for dealing or trading purposes as operating cash flows. It also identifies cash flows from the purchase and sale of dealing or trading securities as operating activities. The classification reflects the fact that such transactions form part of the enterprise's principal revenue-generating activities.

Where it goes wrong. Do not classify every purchase or sale of a security as investing. Securities held for dealing or trading purposes are treated differently from investments held outside the ordinary trading activity.

Authority. AS 3, para 12; Chapter 11, Unit 2.3.1 - Operating Activities

Question 18 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. A bank grants loans to customers as part of its principal revenue-generating activity. How should the cash advances and loans made by the bank be classified?

A bank grants loans to customers as part of its principal revenue-generating activity. How should the cash advances and loans made by the bank be classified?

1. Operating activities (correct answer)
2. Investing activities
3. Financing activities
4. They are excluded as non-cash transactions

Answer: A — Operating activities

Explanation. AS 3 recognises that cash advances and loans made by financial institutions are operating activities when they relate to the institution's main revenue-producing activity. The classification is based on the nature of the enterprise's business and the role of the lending transaction in its ordinary operations.

Where it goes wrong. Do not automatically classify every loan advanced as investing. The chapter distinguishes loans made by financial institutions as part of their principal revenue-generating activity from loans made by other enterprises.

Authority. AS 3, para 12; Chapter 11, Unit 2.3.1 - Operating Activities

Question 19 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. A company pays cash for capitalised research and development costs relating to a self-constructed fixed asset. Under AS 3, the payment is classified as:

A company pays cash for capitalised research and development costs relating to a self-constructed fixed asset. Under AS 3, the payment is classified as:

1. Operating activity because research and development is an expense
2. Investing activity (correct answer)
3. Financing activity
4. A movement between cash and cash equivalents

Answer: B — Investing activity

Explanation. Cash payments to acquire fixed assets, including intangible assets, are investing activities. The chapter expressly includes payments relating to capitalised research and development costs and self-constructed fixed assets within this category because they represent expenditure on resources intended to generate future income and cash flows.

Where it goes wrong. Do not classify the payment solely by the words research and development. The question specifies that the expenditure is capitalised and relates to a fixed asset.

Authority. AS 3, para 15; Chapter 11, Unit 2.3.2 - Investing Activities

Question 20 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. A lessee makes a cash payment that reduces the outstanding liability relating to a finance lease. How should the payment be classified under AS 3?

A lessee makes a cash payment that reduces the outstanding liability relating to a finance lease. How should the payment be classified under AS 3?

1. Operating activity
2. Investing activity
3. Cash equivalent movement
4. Financing activity (correct answer)

Answer: D — Financing activity

Explanation. Financing activities are those that result in changes in the size and composition of the owner's capital and borrowings of the enterprise. AS 3 includes cash payments by a lessee for the reduction of the outstanding liability relating to a finance lease as a financing cash flow.

Where it goes wrong. Do not treat the payment as an investing outflow merely because it relates to an asset acquired under a lease. The question specifically concerns reduction of the finance-lease liability.

Authority. AS 3, para 17; Chapter 11, Unit 2.3.3 - Financing Activities

Question 21 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Scenario. Which statement correctly distinguishes the direct method from the indirect method of reporting cash flows from operating activities?

Which statement correctly distinguishes the direct method from the indirect method of reporting cash flows from operating activities?

1. The direct method starts with net profit, whereas the indirect method reports only cash receipts from customers
2. Both methods disclose only gross cash receipts and gross cash payments
3. The direct method discloses major classes of gross cash receipts and gross cash payments, whereas the indirect method adjusts net profit or loss for specified items and changes (correct answer)
4. The direct method excludes working capital changes, whereas the indirect method excludes non-cash items

Answer: C — The direct method discloses major classes of gross cash receipts and gross cash payments, whereas the indirect method adjusts net profit or loss for specified items and changes

Explanation. Under the direct method, major classes of gross cash receipts and gross cash payments are disclosed. Under the indirect method, net profit or loss is adjusted for non-cash transactions, deferrals or accruals of past or future operating cash receipts or payments and items whose cash effects relate to investing or financing activities. Both methods consider changes in operating current assets and current liabilities.

Where it goes wrong. The indirect method is not a method that ignores working capital. Both methods adjust for changes in operating current assets and current liabilities; the main difference is how the operating cash flow information is presented.

Authority. AS 3, paras 18–21; Chapter 11, Unit 2.4 - Calculation of Cash Flows from Operating Activities

Question 22 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Scenario. A company's profit before tax is ₹480 lakh. It includes depreciation of ₹50 lakh, goodwill amortisation of ₹10 lakh, loss on sale of machinery of ₹5 lakh and interest expense on a loan of ₹20 lakh. It also includes profit on sale of investments of ₹15 lakh. Inventories decreased by ₹30 lakh, trade receivables increased by ₹40 lakh, trade payables decreased by ₹12 lakh, outstanding operating expenses increased by ₹8 lakh and prepaid rent increased by ₹5 lakh. What is the cash generated from operations before income tax?

A company's profit before tax is ₹480 lakh. It includes depreciation of ₹50 lakh, goodwill amortisation of ₹10 lakh, loss on sale of machinery of ₹5 lakh and interest expense on a loan of ₹20 lakh. It also includes profit on sale of investments of ₹15 lakh. Inventories decreased by ₹30 lakh, trade receivables increased by ₹40 lakh, trade payables decreased by ₹12 lakh, outstanding operating expenses increased by ₹8 lakh and prepaid rent increased by ₹5 lakh. What is the cash generated from operations before income tax?

1. ₹531 lakh (correct answer)
2. ₹550 lakh
3. ₹569 lakh
4. ₹511 lakh

Answer: A — ₹531 lakh

Explanation. Adjusted profit before working capital changes is ₹480 + ₹50 + ₹10 + ₹5 + ₹20 - ₹15 = ₹550 lakh. Working capital adjustments are: decrease in inventory +₹30 lakh; increase in trade receivables -₹40 lakh; decrease in trade payables -₹12 lakh; increase in outstanding operating expenses +₹8 lakh; and increase in prepaid rent -₹5 lakh. Net working capital effect is negative ₹19 lakh. Cash generated from operations is ₹550 - ₹19 = ₹531 lakh.

Where it goes wrong. Remember that an increase in prepaid rent is an increase in an operating current asset and reduces cash. Also deduct the profit on sale of investments from the indirect-method operating computation.

Authority. AS 3, para 21; Chapter 11, Unit 2.4.2 - Indirect Method

Question 23 · 2 marks · Chapter 11: Financial Statements of Companies · medium

Scenario. An enterprise reports net cash used in operating activities of ₹40 lakh, net cash generated from investing activities of ₹65 lakh and net cash used in financing activities of ₹20 lakh. Opening cash and cash equivalents were ₹80 lakh. What is the closing balance of cash and cash equivalents?

An enterprise reports net cash used in operating activities of ₹40 lakh, net cash generated from investing activities of ₹65 lakh and net cash used in financing activities of ₹20 lakh. Opening cash and cash equivalents were ₹80 lakh. What is the closing balance of cash and cash equivalents?

1. ₹75 lakh
2. ₹85 lakh (correct answer)
3. ₹95 lakh
4. ₹105 lakh

Answer: B — ₹85 lakh

Explanation. Net change in cash and cash equivalents is the total of operating, investing and financing cash flows: negative ₹40 + ₹65 - ₹20 = positive ₹5 lakh. Add this increase to opening cash and cash equivalents of ₹80 lakh. Closing cash and cash equivalents are therefore ₹85 lakh.

Where it goes wrong. Do not add the absolute values of the three cash flow sections. Preserve the inflow or outflow sign of each section before calculating the net change.

Authority. AS 3, para 1; Chapter 11, Illustrations 4 and 11

Question 24 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Scenario. A company redeems debentures of ₹40 lakh by issuing equity shares directly to the debenture holders. No cash or cash equivalents are transferred. How should this transaction be reflected?

A company redeems debentures of ₹40 lakh by issuing equity shares directly to the debenture holders. No cash or cash equivalents are transferred. How should this transaction be reflected?

1. As an operating cash outflow of ₹40 lakh
2. As an investing cash outflow of ₹40 lakh
3. As a financing cash outflow and an equal financing cash inflow in the main cash flow statement
4. It should be excluded from the main cash flow statement and disclosed separately as a significant non-cash transaction (correct answer)

Answer: D — It should be excluded from the main cash flow statement and disclosed separately as a significant non-cash transaction

Explanation. The redemption is settled by issue of equity shares and does not involve cash or cash equivalents. Significant investing and financing transactions that do not require the use of cash or cash equivalents are excluded from the cash flow statement. They are disclosed elsewhere in the financial statements in a manner that provides relevant information about the activity.

Where it goes wrong. The transaction changes the composition of share capital and borrowings, but that alone does not make it a cash flow. A cash flow statement records cash and cash-equivalent movements, not non-cash conversions.

Authority. AS 3, para 40; Chapter 11, Illustration 11 - Significant non-cash items

Question 25 · 2 marks · Chapter 11: Financial Statements of Companies · hard

Scenario. Under the indirect method, a company has included a profit of ₹14 lakh on sale of machinery in its profit before tax. The machinery was sold for cash proceeds of ₹54 lakh. Which treatment is correct?

Under the indirect method, a company has included a profit of ₹14 lakh on sale of machinery in its profit before tax. The machinery was sold for cash proceeds of ₹54 lakh. Which treatment is correct?

1. Add ₹14 lakh to operating profit and show ₹54 lakh as financing inflow
2. Deduct ₹14 lakh from operating profit and show only ₹40 lakh as investing inflow
3. Deduct ₹14 lakh from operating profit and show the full ₹54 lakh as investing inflow (correct answer)
4. Make no adjustment to operating profit and show ₹54 lakh as operating inflow

Answer: C — Deduct ₹14 lakh from operating profit and show the full ₹54 lakh as investing inflow

Explanation. The profit on sale of machinery is deducted from profit in the indirect-method operating computation because the gain relates to an investing transaction. The actual cash proceeds from disposal of the machinery are presented in investing activities. Therefore, ₹14 lakh is deducted from operating profit and the full sale proceeds of ₹54 lakh are shown as an investing cash inflow.

Where it goes wrong. Do not confuse the accounting profit with the cash proceeds. The gain is removed from operating profit, but the investing section reports the actual cash received on disposal.

Authority. AS 3, paras 15 and 21; Chapter 11, Unit 2.4.2 and Unit 2.5