Chapter 21: The Statement of Cash Flows Revisited

4 examples of noncash transactions that would be reported

1. Acquiring an asset by incurring a *debt payable to the seller* 2. Acquiring use of an asset by *entering into a lease agreement* 3. *Converting debt* into common stock or other equity securities 4. *Exchanging noncash assets* or liabilities *for other noncash assets* or liabilities

Typically, the information available to assist the statement preparer includes ?

1. An income statement for the year 2. Balance sheets for *both the current and preceding years* (comparative statements)

4 benefits of then direct method

1. Each major class of operating cash receipts is listed separately. 2. Each major class of cash payments listed separately. 3. Payments subtracted from receipts determines net cash provided (used) by operating activities. 4. Preferred method

The Statement of Cash Flows should include the following (5) pieces information

1. How a business *obtains* and *spends cash* 2. *Borrowing* and *repayment activities* 3. *Sale* and *repurchase* of its ownership *securities* 4. *Dividend payments - other distributions* 5. *Other factors* affecting a company's liquidity or solvency

What are limitations of the income statement wit respect to cash flows?

1. Information about the *timing* of cash flows is not shown 2. The information is provided only *indirectly*

2 disadvantages of the indirect method

1. Less Informative. 2. Only net cash provided/used by operating activities is shown.

What are some examples of cash equivalents?

1. Money market funds 2. Treasury bills 3. Commercial paper

Information for the statement comes from (3) sources

1. comparative balance sheet 2. income statement for the current period 3. analysis of each non-cash balance sheet account

What are the 2 requirements of the statement of cash flows?

1. the *reconciliation of the net increase or decrease in cash* with the *change in the balance of the cash account* and 2. Noncash investing and financing activities.

The statement of cash flows does not differentiate between

Amounts held as cash and amounts held in cash equivalent investments.

Under the direct method what happens to items on the income statement that have no cash effect? Example

Depreciation expense: It is simply excluded because it does not affect cash

A major portion of financing for many companies is provided by who?

External sources: Shareholders and creditors.

Interest payments and Dividend payments under IFRS

Interest received and dividends received normally are classified as investing activities.

How are interest and dividends treated differently on the statement of cash flows?

Interest, unlike dividends, *is a determinant of net income* and therefore an *operating activity*

Information about net income on an accrual basis provides more information about what than what?

It provides a greater indication of current operating performance than does information about *current cash receipts and payments*

Information in the cash flows from operating activities of cash flows lets statement users know what the financing of a company?

Know the extent of available internal financing

Why is the statement of cash flows an effective means of getting the full picture of cash inflows and outflows from a corporation as an investor?

The income statement measures activities of the business on an accrual basis but, the cash received for these activities is not always reported in that same period.

Why are short-term investments treated the same as cash and cash equiv on the statement of cash flows?

They are equiv to cash b/c of how quickly they can be converted to cash

Main reasons companies don't use the direct method

They are required to show the reconciliation of net income to a cash basis, so you are effectively doing both an indirect and direct method

2 difference between U.S. GAAP and IFRS statement of cash flows

U.S. GAAP designates (a) interest payments and interest received as operating cash flows and (b) dividend payments as financing cash flows and dividends received as operating cash flows (*IAS No. 7, on the other hand, allows more flexibility*)

How is a dividend viewed on the statement of cash flows?

Viewed as a *distribution of net income* and not an expense

A statement of cash flows can not only indicate the amount of cash flows but,

Whether those cash flows are coming from internal operations or from outside resources

Investors are more willing to invest in a company

Whose cash inflows are greater than its cash outflows.

3 common types of*cash payments* included in the cash flows from *investing activities*

(1) PPE and other productive assets (except inventories) (2) Investments in securities (except cash equivalents and trading securities) (3) Nontrade receivables

Noncash investing and financing activity Example How is it reported?

Acquiring equipment (an investing activity) by issuing a long-term note payable (a financing activity), are reported in a separate disclosure schedule or note

Cash flows from operation activities are both cash inflows and outflows of cash that result from what activities?

Activities reported on the *income statement*

Cash flows from investing activities

Are both outflows and inflows of cash caused by the *acquisition and disposition of assets*

The cash received from the sale of common stock is reported as ?

As a *financing activity*

Nature of cash flows can be explained by analyzing non-cash accounts. Why?

Assets = Liabilities + Owner's Equity Cash + Other Assets = Liabilities + Owner's Equity Cash = Liabilities + Owner's Equity - Other Assets Therefore: *Change in Cash = Change in Other Accounts*

Investors and creditor require what from a corporation

Cash flows

The *cash effects* of the elements of net income are reported as what in cash flows?

Cash flows from operating activities

Both U.S. GAAP and IFRS require a statement of cash flows that

Classifies cash flows into operating, investing, or financing activities

Under IFRS statement of cash flows

Companies can report interest and dividends received and paid as operating, investing, or financing cash flows, provided that they are classified consistently from period to period.

Noncash investing and financing activities are reported

Either on the same page as the statement of cash flows or in a related schedule or note

Cash flows from operating activities should reflect the cash effects of items that what?

Enter into the determination of *net income*

The Statement of Cash Flows reports information about the events and transactions that affect cash. What cash am I talking about?

Explaining is changes in the first line of the balance sheet.

Creditors want to ensure a company

Has sufficient cash flowing into the company to meet its credit obligations.

Reconstructing the events and transactions that occurred during the period helps what?

Identify the operating, investing, and financing activities to be reported.

Interest payments and Dividend payments under GAAP

Interest payments usually are reported as operating activities. Dividend payments usually are reported as financing activities as under U.S. GAAP.

The statement of cash flows provides information about cash flows that what?

Is lost when reported only indirectly by the balance sheet and the income statement

Where does restricted cash fit into the statement of cash flow?

It is treated as a cash and cash equivalent

Benefits of the statement of cash flows

It presents information about cash flows that the other statements either (a) do not provide or (b) provide only indirectly

Concept of the statement of cash flows

It provides a list of the cash inflows and outflows that occurred during the reporting period.

Each firm's policy regarding which short-term highly liquid investments it classifies as cash equivalents should be reported where?

It should be disclosed in the notes to the financial statements

How does the indirect method work?

Net cash increase/decrease from operating activities would be derived *indirectly* by starting with *reported net income* and working *backwards* to convert that amount to a *cash basis*

Noncash transactions such as the distribution of stock dividends, are

Noy=t considered investing or financing activities and are not reported (They do not affect a company's assets or liabilities)

Decision makers rely heavily on the information reported in

Periodic financial statements to project a company's cash-generating ability

Cash equiv are

Short term, highly liquid investments that can be readily converted to cash with little loss of risk (FASB)

Some important questions are not easily answered from the information what provide?

The balance sheet and income statement provide

How does the direct method work?

The cash effect of reach operating activity on the income statement is reported *directly* to the statement of cash flows

The *consolidated* statement of cash flows provides information about what?

The changes in cash and cash equiv. Cash equiv: (Highly liquid investment with maturities of less than 3 months when acquired)

Management wishes to know if

The company can meet unexpected obligations/ Any excess cash may be invested

Cash flows to investors and creditors depend on

The corporation generating cash flows to itself.

Why is inventory treated differently from property, plant, and equipment and intangible assets when classifying their cash effects if they are all acquired for the purpose of producing revenues?

The difference is that inventory typically is purchased for the purpose of *being used as part of the firm's current operations* While other assets are purchased as investments to benefit the business over a relatively long period of time

To be classified as a cash and cash equiv what must be true?

The investment must have a maturity date not longer than 3 months from the purchase date

Why is depreciation expense added to he cash flows fro operating activities?

The only reason it's there is that it was subtracted on the income statement to arrive at net income (loss) so we have to add it back in order to arrive at a cash based net income.

The income statement reports the what of a corporation?

The success of a business in generating a profit from its operations

What is the same between the direct and indirect method?

The way cash flows from *investing and financing activities* are presented

Cash and cash equivalents are

These are short-term, highly liquid investments that can readily be converted to cash with little risk of loss.

To make a projection on if company can make interest payments on time and repay the loan when it is due *what do investors need to have*?

They rely heavily on the info reported in periodic financial statements. Cash flows into and out of a business enterprise are the most useful for investors and creditors to base their decision.

What transactions *should not* be reported in the statement of cash flows?

Transaction that involve transfers from cash to cash equiv (purchase of a 3 month treasury bill) Or transaction from cash equiv to cash) (the sale of a Treasury bill) *total cash and cash equiv for this section remain unchanged*

To determine the cost of goods purchased (not necessarily cash paid) during the year

We compare cost of goods sold with the change in inventory and the change in the account payable balance

The statement of cash flows fills an information gap left by the

balance sheet and the income statement

In the current year, when the bonds are retired, the cash outflow classified as a what activity?

financing activity

Providing a cash return (dividend) to common shareholders is a what activity?

financing activity

When the bonds being retired were *issued in a prior year*, that cash inflow was reported as a what activity?

financing activity

Paying interest to creditors is classified as a what activity?

operating activity