Q.Statement I : Issue of Debentures will result in inflow of cash. Statement II : Issue of Debentures to the vendors for purchase of machinery will result in outflow of cash. Choose the correct option from the following : (A) Both statements are correct. (B) Both statements are incorrect. (C) Statement I is correct and Statement II is incorrect. (D) Statement I is incorrect and Statement II is correct.
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🔒 Start your 14-day free trial to unlock the full solution →Part (a)Concept understanding — Cash Flow Classification
Cash Flow Classification: From Pocket Money to a Business
Think about your own monthly allowance. You get some money from your parents (inflow), you spend on snacks, movies, and stationery (outflow), and maybe you save a bit or borrow from a friend. Now, if someone asked you, "Where did your money come from and where did it go?", you'd naturally group those transactions: money from parents, money spent on fun, money saved. That's exactly what Cash Flow Classification does for a business — it sorts every cash transaction into one of three buckets so you can see the story behind the cash.
The Three Buckets: Operating, Investing, Financing
The NCERT Class-12 Accountancy textbook (Part II, Chapter 6) defines Cash Flow Statement as a statement that shows inflows and outflows of cash and cash equivalents from operating, investing, and financing activities. Let's break each one down.
1. Operating Activities (The Core Business)
These are the cash flows from the main revenue-producing activities of the business. For a manufacturing company, that means cash from selling goods and cash paid to suppliers, employees, and for rent. Think of it as the cash generated by the business's day-to-day operations.
Examples:
- Cash received from customers
- Cash paid to suppliers
- Cash paid for salaries, rent, taxes
- Cash received from interest or dividends (for a non-financial company, these are often classified as operating or investing — NCERT allows both, but operating is common)
2. Investing Activities (Buying and Selling Long-Term Assets)
These are cash flows from the purchase and sale of long-term assets and investments that are not cash equivalents. This bucket answers: "Is the business investing in its future growth or selling off its assets?"
Examples:
- Purchase of machinery, building, land (cash outflow)
- Sale of old machinery (cash inflow)
- Purchase of shares or debentures of other companies (cash outflow)
- Sale of such investments (cash inflow)
- Loans given to others (cash outflow) and repayment received (cash inflow)
3. Financing Activities (How the Business is Funded)
These are cash flows from transactions with the owners and lenders. This bucket shows how the business raises money and repays those who funded it.
Examples:
- Issue of shares or debentures (cash inflow)
- Repayment of long-term loans (cash outflow)
- Payment of dividends (cash outflow)
- Buyback of shares (cash outflow)
- Proceeds from long-term borrowings (cash inflow)
Why Does This Classification Matter?
A single number like "net cash flow" tells you very little. But when you see that a company has negative cash flow from operations but positive cash flow from financing, you immediately know: the company is burning cash from its core business and is surviving by borrowing or issuing shares. That's a red flag.
Conversely, a company with strong positive operating cash flow but negative investing cash flow is likely a healthy business investing in growth. The classification gives you the diagnosis of the business's financial health — not just the final number.
Accounting Treatment: No Debit/Credit Here
This is a crucial point for Class-12 students: The Cash Flow Statement is not a ledger account. It does not involve debiting or crediting any account. It is a statement prepared from the Balance Sheet and Statement of Profit & Loss (Income Statement). You do not pass journal entries for it.
Instead, you reclassify the changes in balance sheet items and income statement items into the three categories. The format is prescribed by the NCERT and is based on AS-3 (Revised).
The NCERT Format (Proforma) of Cash Flow Statement
Below is the standard format as per NCERT Class-12 Accountancy (Part II, Chapter 6). Note that the textbook uses ₹ for amounts.
| Particulars | Amount (₹) |
|---|---|
| A. Cash Flow from Operating Activities | |
| Net Profit before Tax and Extraordinary Items | XXX |
| Adjustments for: | |
| Depreciation | + XXX |
| Loss on Sale of Asset | + XXX |
| Gain on Sale of Asset | – XXX |
| Operating Profit before Working Capital Changes | XXX |
| Changes in Working Capital: | |
| Increase in Current Assets | – XXX |
| Decrease in Current Assets | + XXX |
| Increase in Current Liabilities | + XXX |
| Decrease in Current Liabilities | – XXX |
| Cash Generated from Operations | XXX |
| Less: Income Tax Paid | (XXX) |
| Net Cash Flow from Operating Activities | XXX |
| B. Cash Flow from Investing Activities | |
| Purchase of Fixed Assets | (XXX) |
| Sale of Fixed Assets | XXX |
| Purchase of Investments | (XXX) |
| Sale of Investments | XXX |
| Interest Received | XXX |
| Dividends Received | XXX |
| Net Cash Flow from Investing Activities | XXX |
| C. Cash Flow from Financing Activities |
Part (b)Concept understanding — Cash Flow Classification
Cash Flow Classification: From Pocket Money to a Business
Think about your own monthly allowance. You get some money from your parents (inflow), you spend on snacks, movies, and stationery (outflow), and maybe you save a bit or borrow from a friend. Now, if someone asked you, "Where did your money come from and where did it go?", you'd naturally group those transactions: money from parents, money spent on fun, money saved. That's exactly what Cash Flow Classification does for a business — it sorts every cash transaction into one of three buckets so you can see the story behind the cash.
The Three Buckets: Operating, Investing, Financing
The NCERT Class-12 Accountancy textbook (Part II, Chapter 6) defines Cash Flow Statement as a statement that shows inflows and outflows of cash and cash equivalents from operating, investing, and financing activities. Let's break each one down.
1. Operating Activities (The Core Business)
These are the cash flows from the main revenue-producing activities of the business. For a manufacturing company, that means cash from selling goods and cash paid to suppliers, employees, and for rent. Think of it as the cash generated by the business's day-to-day operations.
Examples:
- Cash received from customers
- Cash paid to suppliers
- Cash paid for salaries, rent, taxes
- Cash received from interest or dividends (for a non-financial company, these are often classified as operating or investing — NCERT allows both, but operating is common)
2. Investing Activities (Buying and Selling Long-Term Assets)
These are cash flows from the purchase and sale of long-term assets and investments that are not cash equivalents. This bucket answers: "Is the business investing in its future growth or selling off its assets?"
Examples:
- Purchase of machinery, building, land (cash outflow)
- Sale of old machinery (cash inflow)
- Purchase of shares or debentures of other companies (cash outflow)
- Sale of such investments (cash inflow)
- Loans given to others (cash outflow) and repayment received (cash inflow)
3. Financing Activities (How the Business is Funded)
These are cash flows from transactions with the owners and lenders. This bucket shows how the business raises money and repays those who funded it.
Examples:
- Issue of shares or debentures (cash inflow)
- Repayment of long-term loans (cash outflow)
- Payment of dividends (cash outflow)
- Buyback of shares (cash outflow)
- Proceeds from long-term borrowings (cash inflow)
Why Does This Classification Matter?
A single number like "net cash flow" tells you very little. But when you see that a company has negative cash flow from operations but positive cash flow from financing, you immediately know: the company is burning cash from its core business and is surviving by borrowing or issuing shares. That's a red flag.
Conversely, a company with strong positive operating cash flow but negative investing cash flow is likely a healthy business investing in growth. The classification gives you the diagnosis of the business's financial health — not just the final number.
Accounting Treatment: No Debit/Credit Here
This is a crucial point for Class-12 students: The Cash Flow Statement is not a ledger account. It does not involve debiting or crediting any account. It is a statement prepared from the Balance Sheet and Statement of Profit & Loss (Income Statement). You do not pass journal entries for it.
Instead, you reclassify the changes in balance sheet items and income statement items into the three categories. The format is prescribed by the NCERT and is based on AS-3 (Revised).
The NCERT Format (Proforma) of Cash Flow Statement
Below is the standard format as per NCERT Class-12 Accountancy (Part II, Chapter 6). Note that the textbook uses ₹ for amounts.
| Particulars | Amount (₹) |
|---|---|
| A. Cash Flow from Operating Activities | |
| Net Profit before Tax and Extraordinary Items | XXX |
| Adjustments for: | |
| Depreciation | + XXX |
| Loss on Sale of Asset | + XXX |
| Gain on Sale of Asset | – XXX |
| Operating Profit before Working Capital Changes | XXX |
| Changes in Working Capital: | |
| Increase in Current Assets | – XXX |
| Decrease in Current Assets | + XXX |
| Increase in Current Liabilities | + XXX |
| Decrease in Current Liabilities | – XXX |
| Cash Generated from Operations | XXX |
| Less: Income Tax Paid | (XXX) |
| Net Cash Flow from Operating Activities | XXX |
| B. Cash Flow from Investing Activities | |
| Purchase of Fixed Assets | (XXX) |
| Sale of Fixed Assets | XXX |
| Purchase of Investments | (XXX) |
| Sale of Investments | XXX |
| Interest Received | XXX |
| Dividends Received | XXX |
| Net Cash Flow from Investing Activities | XXX |
| C. Cash Flow from Financing Activities |
Issuing debentures for cash brings money into the business, so Statement I is a correct cash inflow reported under financing activities. However, issuing debentures directly to vendors to purchase machinery is a non-cash transaction — no cash actually moves in or out — so Stateme …
Statement I is true because issuing debentures for cash is a genuine financing inflow, while Statement II is false because issuing debentures to vendors for machinery is a non-cash item that causes neither inflow nor outflow. The correct option is (C).
A Cash Flow Statement records only transactions that actually move cash. We must test each statement against this rule.
Statement I — Correct. When a company issues debentures and receives cash in return, cash flows into the business. This is a source of finance, so it is shown as an inflow under Financing Activities. The statement is therefore true. …
- AHSEC Assam Higher Secondary Final Class 12 (Commerce) 2026Set ANNUAL2 marksQ.Write the meaning of 'cash flow from financing activities'.
›Reveal solutionSolution
Cash from changes in capital and borrowings.
Cash flow from financing activities shows the cash effects of transactions that change the size and composition of the owners' capital and borrowings of the firm. Inflows: proceeds from the issue of shares and debentures or raising of loans. Outflows: redemption of debentures/repayment of loans, buy-back of shares, and payment of dividend and …
- AHSEC Assam Higher Secondary Final Class 12 (Commerce) 2025Set ANNUAL2 marksQ.Write two features of cash flow statement.
›Reveal solutionSolution
Cash-only, classified into three activities.
Features of a cash flow statement:
- It deals only with cash and cash equivalents — actual inflows and outflows during the period.
- It classifies the flows into operating, investing and financing activities (AS-3), and reconciles the opening and closing cash balances, thereby showing the sources and uses of cash. …
- AHSEC Assam Higher Secondary Final Class 12 (Commerce) 2024Set ANNUAL2 marksQ.(OR) Write the meaning of 'Cash flow from investing activities'.
›Reveal solutionSolution
Cash flows from buying/selling long-term assets and investments.
Cash flow from investing activities shows the cash effect of transactions in long-term (fixed) assets and non-current investments that are not part of cash equivalents. Typical items are: purchase and sale of plant, land, buildings and other fixed assets; purchase and sale of shares/debentures of other companies (non-trade); and interest and dividend received on such investments. A net outflow here usually indicates the firm i …
- AHSEC Assam Higher Secondary Final Class 12 (Commerce) 2024Set ANNUAL2 marksQ.(OR) What is meant by the term 'cash equivalents'?
›Reveal solutionSolution
Short-term, highly liquid near-cash investments.
Cash equivalents are short-term, highly liquid investments that can be converted into a known amount of cash almost immediately and carry an insignificant risk of change in value. An investment normally qualifies only if it has a short maturity (say, three months or less from the date of acquisition) — examples are treasury bills, commercial paper and marketable securities held to meet short-term commitments rather than for investment.
…
- AHSEC Assam Higher Secondary Final Class 12 (Commerce) 2023Set ANNUAL2 marksQ.What is the meaning of Cash Flow from Investing Activities?
›Reveal solutionSolution
Investing activities = cash flows from buying/selling fixed assets and investments.
Investing activities are the acquisition and disposal of long-term assets and other investments not included in cash equivalents. Cash flow from investing activities therefore includes: outflows such as the purchase of fixed assets (land, building, plant, machinery) and purchase of investments; and inflows such as the sale of fixed assets and investments and the interest and dividend received on investments and loans. These flows reflect the extent to which the firm is build …
- AHSEC Assam Higher Secondary Final Class 12 (Commerce) 2023Set ANNUAL2 marksQ.(OR) What is meant by the term 'Cash Equivalents'?
›Reveal solutionSolution
Cash equivalents = near-cash short-term liquid investments with insignificant risk.
Cash equivalents are short-term, highly liquid investments that are readily convertible into a known amount of cash and are subject to an insignificant risk of change in value. They are held to meet short-term cash commitments rather than for investment purposes. Examples include treasury bills, commercial paper, short-term deposits and marketable securities with a short maturity (usually three months or less from the date of acquisition). Together with cash in hand and at …
- AHSEC Assam Higher Secondary Final Class 12 (Commerce) 2022Set ANNUAL2 marksQ.What is the meaning of Cash Flow from Financing Activities?
›Reveal solutionSolution
Financing activities = cash flows that change the firm's capital and borrowings (shares, debentures, loans, dividend, interest).
Financing activities are those activities which result in a change in the size and composition of the owner's capital (including preference capital) and the borrowings of the enterprise. Cash flow from financing activities therefore includes: inflows such as cash received from issue of shares and debentures and from raising long-term loans; and outflows such as repayment of loans, redemption of debentures/preference shares, buy-back of shares, and payment of dividend and interest. These are shown separately in the cash flow stat …
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