Chapter 13 Learning Opportunities - ACC 102: Managerial Accounting

Explain how a worksheet may be helpful in preparing a statement of cash flows.

A worksheet can be used to analyze the changes in balance sheet accounts other than Cash and, thereby, determine the related cash flows. In the top portion of the worksheet, entries are made summarizing the changes in each noncash account. In the bottom half, offsetting entries are made to represent the cash effects of the transactions summarized in the top portion. The entries in the bottom half of the worksheet are classified into the same categories as in a statement of cash flows - operating, investing, and financing. The statement of cash flows then is prepared from the data in the bottom portion of the worksheet.

Describe how cash transactions are classified in a statement of cash flows.

Cash flows are classified as (1) operating activities, (2) investing activities, or (3) financing activities. Receipts and payments of interest are classified as operating activities.

Compute the cash flows relating to investing and financing activities.

Cash flows from investing and financing activities are determined by examining the entries in the related asset and liability accounts, along with any related gains or losses shown in the income statement. Debit entries in asset accounts represent purchases of assets (an investing activity). Credit entries in asset accounts represent the cost of assets sold. The amount of these credit entries must be adjusted by any gains or losses recognized on these sales transactions. Debit entries to liability accounts represent repayment of debt, while credit entries represent borrowing. Both types of transactions are classified as financing activities. Other financing activities include the issuance of stock (indicated by credits to the pad-in capital accounts) and payment of dividends (indicated by a debit change in the Retained Earnings account).

Discuss the likely effects of various business strategies on cash flows.

It is difficult to predict the extent to which a business strategy will affect cash flows. However, an informed decision maker should understand the direction in which a strategy is likely to affect cash flows - both in the short term and over a longer term.

Explain why net income differs from net cash flows from operating activities.

Net income differs from net operating cash flows for several reasons. One reason is noncash expenses, such as depreciation and the amortization of intangible assets. These expenses, which require no cash outlays when they are recognized, reduce net income but do not require cash payments. Another reason is the many timing differences existing between the recognition of revenue and expense and the occurrence of the underlying cash flows. Finally, nonoperating gains and losses enter into the determination of net income, but the related cash flows are classified as investing or financing activities, not operating activities.

Distinguish between the direct and indirect methods of reporting operating cash flows.

The direct and indirect methods are alternative formats for reporting net cash flows from operating activities. The direct method shows the specific cash inflows and outflows comprising the operating activities of the business. By the indirect method, the computation begins with accrual-based net income and then makes adjustments necessary to arrive at net cash flows from operating activities. Both methods result in the same dollar amount of net cash flows from operating activities. When the direct method is used, the indirect method must also be disclosed.

Compute net cash flows from operating activities using the indirect method.

The indirect method uses net income (as reported in the income statement) as the starting point in the computation of net cash flows from operating activities. Adjustments to net income necessary to arrive at net cash flows from operating activities are described in three categories: noncash expenses, timing differences, and nonoperating gains and losses. Adjustments reconcile net income (accrual basis) to net cash flows from operating activities. Specific adjustments from each category are illustrated in the summary analysis of the indirect method on page 579.

Compute the major cash flows relating to operating activities.

The major operating cash flows are (1) cash received from customers, (2) cash paid to suppliers and employees, (3) interest and dividends received, (4) interest paid, and (5) income taxes paid. These cash flows are computed by converting the income statement amounts for revenue, cost of goods sold, and expenses from the accrual basis to the cash basis. This is done by adjusting the income statement amounts for changes occurring over the period in related balance sheet accounts.

Explain the purposes and uses of a statement of cash flows.

The primary purpose of a statement of cash flows is to provide information abut the cash receipts and cash payments of the entity and how they relate to the entity's operating, investing, and financing activities. Readers of financial statements use this information to assess the liquidity of a business and to evaluate its ability to generate positive cash flows in future periods, pay dividends, and finance growth.