Lee O’Brien is the president and majority shareholder of Fluff N’ Stuff, Inc., a small retail store chain. Recently, O’Brien submitted a loan application for Fluff N’ Stuff, Inc., to Montvale National Bank. It called for a $300,000, 7%, 10-year loan to help finance the construction of a building and the purchase of store equipment, costing a total of $340,000, to enable Fluff N’ Stuff, Inc., to open a store in Montvale. Land for this purpose was acquired last year. The bank’s loan officer requested a statement of cash flows in addition to the most recent income statement, balance sheet, and retained earnings statement that O’Brien had submitted with the loan application.,As a close family friend, O’Brien asked you to prepare a statement of cash flows. From the records provided, you prepared the following statement.,After reviewing the statement, O’Brien telephoned you and commented, “Are you sure this statement is right?” O’Brien then raised the following questions:,1. “How can depreciation be a cash flow?”,2. “Issuing common stock for the land is listed in a separate schedule. This transaction has nothing to do with cash! Shouldn’t this transaction be eliminated from the statement?”,3. “How can the gain on sale of investments be a deduction from net income in determining the cash flow from operating activities?”,4. “Why does the bank need this statement anyway? They can compute the increase in cash from the balance sheets for the last two years.”,After jotting down O’Brien’s questions, you assured him that this statement was “right.”,However, to alleviate O’Brien’s concern, you arranged a meeting for the following day.,a. How would you respond to each of O’Brien’s questions?,b. Do you think that the statement of cash flows enhances the chances of Fluff N’ Stuff, Inc., receiving the loan?Discuss.
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