Dillip Lachgar is the president and majority shareholder of Argon Inc., a small retail store chain. Recently, Dillip submitted a loan application for Argon Inc. to Compound Bank. It called for a $600,000, 9%, 10-year loan to help finance the construction of a building and the purchase of store equipment, costing a total of $750,000. This will enable Argon Inc. to open a store in the town of Compound. 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 Dillip had submitted with the loan application.

As a close family friend, Dillip asked you to prepare a statement of cash flows. From the records provided, you prepared the following statement:

After reviewing the statement, Dillip telephoned you and commented, “Are you sure this statement is right?” Dillip 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 the 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 Dillip’s questions, you assured him that this statement was “right.” But to alleviate Dillip’s concern, you arranged a meeting for the following day.
a. How would you respond to each of Dillip’s questions?
b. Do you think that the statement of cash flows enhances the chances of Argon Inc. receiving the loan? Discuss.