ExpertMedium1 markMultiple Choice
ACCA · Question 64 · Preparing basic financial statements
Section B - Case 2: Single Entity Accounts & Ratio Analysis
*Scenario: Horizon Wind Farms Ltd has prepared draft financial statements for the year ended 31 December 20X8. The draft net profit is $850,000. Draft Revenue is $4,000,000 and Cost of Sales is $2,200,000. The following adjustments have not yet been processed:
- Depreciation on new turbines of $50,000 was omitted.
- An annual insurance premium of $12,000 paid on 1 July 20X8 was expensed in full.
- Closing inventory was overvalued by $30,000.
- An irrecoverable debt of $15,000 needs to be written off.
Equity comprises Share capital $1,000,000 and Retained earnings $2,000,000. There is a long-term loan of $1,500,000.*
How does the $50,000 depreciation adjustment affect the net cash flow from operating activities?
Section B - Case 2: Single Entity Accounts & Ratio Analysis
*Scenario: Horizon Wind Farms Ltd has prepared draft financial statements for the year ended 31 December 20X8. The draft net profit is $850,000. Draft Revenue is $4,000,000 and Cost of Sales is $2,200,000. The following adjustments have not yet been processed:
- Depreciation on new turbines of $50,000 was omitted.
- An annual insurance premium of $12,000 paid on 1 July 20X8 was expensed in full.
- Closing inventory was overvalued by $30,000.
- An irrecoverable debt of $15,000 needs to be written off.
Equity comprises Share capital $1,000,000 and Retained earnings $2,000,000. There is a long-term loan of $1,500,000.*
How does the $50,000 depreciation adjustment affect the net cash flow from operating activities?
Answer options:
A.
It decreases net cash flow by $50,000
B.
It increases net cash flow by $50,000
C.
It has no effect on the net cash flow from operating activities
D.
It decreases cash flow from investing activities
How to approach this question
Remember that depreciation is a non-cash expense. It reduces profit, but because no cash leaves the business, it is added back to profit in the Statement of Cash Flows. The net effect on cash is zero.
Full Answer
C.It has no effect on the net cash flow from operating activities✓ Correct
Depreciation is a non-cash expense. When preparing a Statement of Cash Flows using the indirect method, depreciation is deducted to arrive at Net Profit, but then added back to Net Profit to find cash generated from operations. Therefore, the adjustment has absolutely no impact on the final cash flow figure.
Common mistakes
Assuming that because it is an expense, it must reduce cash flow.
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