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. …
- PSEB Punjab Class 12 (Commerce) 2026Set ANNUAL1 markMCQQ.Cash Flow statement is useful for ________ financial planning. (long term/short term)(a) long term(b) short term
›Reveal solutionSolution
Short term.
A cash flow statement shows the sources and uses of cash during a period and the cash likely to be available. This helps the management plan for NEAR-TERM cash needs - paying creditors, dividends and expenses. Hence it is useful mainly for …
- PSEB Punjab Class 12 (Commerce) 2025Set ANNUAL1 markMCQQ.Cash flow statement is prepared on the basis of ________ issued by Institute of Chartered Accountants of India. (AS-3/AS-3 Revised)(a) AS-3(b) AS-3 Revised
›Reveal solutionSolution
AS-3 (Revised).
A cash flow statement is prepared in accordance with Accounting Standard-3 (Revised), 'Cash Flow Statements', issued by the Institute of Chartered Accountants of India (ICAI). It classifies cash flow …
- PSEB Punjab Class 12 (Commerce) 2025Set ANNUAL1 markQ.Harsh Ltd., a financing company obtained loans and advances of ₹ 10,00,000 for the year @ 12% per annum. In which activity will it be included while preparing cash flow statement?
›Reveal solutionSolution
Operating Activities.
Classification depends on the NATURE of the enterprise's business. For an ordinary company, loans taken/given would be financing/investing. But for a FINANCING company, dealing in loans and advances is its PRINCIPAL REVENUE-PRODUCING activity. Hence Harsh Ltd.'s loans and advances (and the related interest) are treated as part of OPERATING activities whil …
- PSEB Punjab Class 12 (Commerce) 2024Set ANNUAL1 markMCQQ.Mention the net amount of 'source' or 'use' of cash when a fixed asset having book value of ₹ 15,000 is sold at a loss of ₹ 5,000:(a) Use ₹ 5,000(b) Source ₹ 10,000(c) Use ₹ 15,000(d) Source ₹ 15,000
›Reveal solutionSolution
(b) Source Rs 10,000.
Sale value of the fixed asset = Book value - Loss on sale = 15,000 - 5,000 = 10,000. Cash actually received is Rs 10,000, which is a SOURCE (inflow) of cash (an investing activity). The loss of 5,00 …
- PSEB Punjab Class 12 (Commerce) 2024Set ANNUAL1 markQ.Explain Financing Activities.
›Reveal solutionSolution
Financing activities relate to raising and repaying long-term funds - share capital and borrowings.
As per AS-3, financing activities are those that result in changes in the SIZE and COMPOSITION of the owners' capital (including preference share capital) and the borrowings of the enterprise. Examples of inflows: proceeds from issue of shares and debentures, and loans raised. Examples of outflows: repayment of loans and debentures, redemption of preference shares, buy-back of equity shares, and payment of dividend and in …
- PSEB Punjab Class 12 (Commerce) 2023Set ANNUAL1 markMCQQ.Bank overdraft is cash equivalent. (True/False)(a) True(b) False
›Reveal solutionSolution
False.
Cash equivalents are short-term, highly liquid investments readily convertible into known amounts of cash (e.g., treasury bills, marketable securities for a short term). A bank overdraft is a borrowing from the bank; in a cash flow statement it is normally treated as a financ …
- PSEB Punjab Class 12 (Commerce) 2023Set ANNUAL1 markMCQQ.Buyback of shares is a financing activity. (True/False)(a) True(b) False
›Reveal solutionSolution
True.
Financing activities are those that change the size and composition of owners' capital and borrowings. Buyback (repurchase) of its own shares reduces the company's share capital and uses cash; the payment is therefore a …
- PSEB Punjab Class 12 (Commerce) 2023Set ANNUAL1 markMCQQ.Which of the following item is considered as cash equivalent?(a) Marketable Securities(b) Debtors(c) Investment(d) Bill of Exchange
›Reveal solutionSolution
(a) Marketable Securities.
Cash equivalents are short-term, highly liquid investments that are readily convertible into known amounts of cash with insignificant risk of change in value. Marketable securities held for a short term qualify. Debtors …
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