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Cash Flow Statement – Class 12 Accountancy notes, important questions and MCQs

NCERT Class 12 Accountancy, chapter 10. Notes, key terms, important questions with answers and MCQs.

Chapter overview

A cash flow statement shows the inflows and outflows of cash and cash equivalents during a period, classified into operating, investing and financing activities. It is prepared as per Accounting Standard 3 (AS 3). It explains why cash changed even when there was profit, helps assess liquidity and is useful for planning.

Cash and activities

Cash includes cash in hand and demand deposits with banks; cash equivalents are short-term, highly liquid investments readily convertible into known amounts of cash, usually with a maturity of three months or less.
Operating activities are the principal revenue-producing activities, such as cash receipts from customers and payments to suppliers and employees.
Investing activities relate to purchase and sale of long-term assets and investments not included in cash equivalents.
Financing activities change the size and composition of owners' capital and borrowings, such as issue of shares, borrowing, repayment and payment of dividend and interest (for non-financial companies).

Cash from operating activities (indirect method)

Start with net profit before tax and extraordinary items.
Add non-cash and non-operating expenses such as depreciation, amortisation and loss on sale of assets; deduct non-operating incomes such as profit on sale of assets and interest or dividend received.
Adjust for changes in working capital: deduct increases in current assets and decreases in current liabilities; add decreases in current assets and increases in current liabilities; then deduct income tax paid.

Classification of interest and dividend

For a non-financial company, interest and dividend received are investing activities, while interest and dividend paid are financing activities.
For a financial company, interest paid and received are operating activities.
Uses: shows sources and uses of cash, helps cash planning and assesses the ability to pay debts and dividends.

Key terms

Cash flow statement: a statement showing inflows and outflows of cash and cash equivalents classified by activities
Cash equivalents: short-term, highly liquid investments with maturity of usually three months or less
Operating activities: the principal revenue-producing activities of an enterprise
Investing activities: acquisition and disposal of long-term assets and investments
Financing activities: activities that change the size and composition of owners' capital and borrowings

Important questions with answers

What are cash equivalents?2 marks

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. An investment normally qualifies as a cash equivalent only if it has a short maturity of three months or less from the date of acquisition.

Classify the following into operating, investing and financing activities for a non-financial company: purchase of goodwill, payment of dividend, cash sales, sale of investments.3 marks

Purchase of goodwill is an investing activity because it is a long-term asset. Payment of dividend is a financing activity because it relates to owners' capital. Cash sales are an operating activity because they are the main revenue-producing activity. Sale of investments is an investing activity.

Explain the indirect method of calculating cash flow from operating activities with an example: net profit before tax ₹1,00,000; depreciation ₹20,000; increase in trade receivables ₹15,000; increase in trade payables ₹10,000; decrease in inventory ₹5,000; income tax paid ₹25,000.5 marks

Under the indirect method, cash flow from operating activities is found by adjusting the net profit before tax for non-cash items, non-operating items and changes in working capital. First, non-cash and non-operating expenses such as depreciation and loss on sale of assets are added back, and non-operating incomes such as profit on sale of assets and interest or dividends received are deducted, giving operating profit before working capital changes. Second, increases in current assets and decreases in current liabilities are deducted, because they use cash, while decreases in current assets and increases in current liabilities are added, because they release cash. Third, income tax paid is deducted. In the example: net profit before tax ₹1,00,000 plus depreciation ₹20,000 gives operating profit before working capital changes of ₹1,20,000. Deduct the increase in trade receivables of ₹15,000, add the increase in trade payables of ₹10,000 and add the decrease in inventory of ₹5,000, giving cash generated from operations of ₹1,20,000. Deduct income tax paid of ₹25,000, and the net cash flow from operating activities is ₹95,000. This shows that although profit was ₹1,00,000, the cash actually generated from operations after tax was ₹95,000.

Quick revision

AS 3; cash and cash equivalents (≤ 3 months).
Operating, investing, financing activities.
Indirect method: profit + non-cash items ± working capital changes − tax.
Interest and dividend: investing/financing for non-financial firms.

Exam tips

Make a table of common items under operating, investing and financing activities.
In the indirect method, remember: increase in current assets is deducted, increase in current liabilities is added.

Practice MCQs

The cash flow statement is prepared as per
1. AS 26
2. AS 3
3. Schedule I
4. Section 135
Show answer
Answer: (b) AS 3. Accounting Standard 3.
Purchase of machinery is a
1. investing activity
2. operating activity
3. financing activity
4. cash equivalent
Show answer
Answer: (a) investing activity. It relates to long-term assets.
Issue of shares for cash is a
1. financing activity
2. investing activity
3. operating activity
4. non-cash item
Show answer
Answer: (a) financing activity. It changes owners' capital.
Depreciation is added back to net profit because it is
1. a non-cash expense
2. a cash income
3. a financing item
4. an investing activity
Show answer
Answer: (a) a non-cash expense. No cash is paid for it.
An increase in trade receivables in the indirect method is
1. added
2. deducted
3. ignored
4. shown in financing
Show answer
Answer: (b) deducted. Cash has not yet been received.
For a non-financial company, interest paid on debentures is a
1. operating activity
2. investing activity
3. cash equivalent
4. financing activity
Show answer
Answer: (d) financing activity. It is the cost of financing.
Net profit before tax ₹1,00,000; depreciation ₹20,000; increase in trade receivables ₹15,000; increase in trade payables ₹10,000; decrease in inventory ₹5,000. Cash from operations before tax is
1. ₹1,10,000
2. ₹1,20,000
3. ₹1,30,000
4. ₹1,00,000
Show answer
Answer: (b) ₹1,20,000. 1,00,000 + 20,000 − 15,000 + 10,000 + 5,000.
For a financial enterprise such as a bank, interest received is classified as
1. investing activity
2. not shown
3. financing activity
4. operating activity
Show answer
Answer: (d) operating activity. It is its main business.

All chapters of Class 12 Accountancy

Written by Kundali IQ from standard, well-established facts to help with revision. This is not an official NCERT publication; always read your textbook too.