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. …
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