Chapter 23: Statement of Cash Flows

According to IFRS, companies can define "cash and cash equivalents" as

"net monetary assets"—that is, as "cash and demand deposits and highly liquid investments less short-term borrowings."

cash inflows from financing activities

-from sale of equity securities -from issuance of debt (bonds and notes)

cash inflows from investing activities

-from sale of property plant and equipment -from sale of debt or equity securities of other entities -from collection of principals on loans to other entities

cash inflows from operating activities

-from sales of goods and services -from returns on loans (interest) and on equity securities (dividends)

purposes of statement of cash flows are

-to provide information about a company's cash receipts and cash payments during a period -to provide cash-basis information about the company's operating, investing, and financing activities

cash outflows from investing activities

-to purchase PP&E -to purchase debt or equity securities from other entities -to make loans to other entities

cash outflows from financing activities

-to stockholders as dividends -to redeem long-term debt or reacquire capital stock

significant noncash transactions

Transactions and events that are investing or financing activities but that do not involve cash and thus are omitted from the statement of cash flows. These include acquisition of assets by assuming liabilities or by issuing equity securities, exchanges of nonmonetary assets, refinancing of long-term debt, conversion of debt or preferred stock to common stock, and issuance of equity securities to retire debt. Companies either disclose these transactions in a separate schedule on the statement of cash flows or in a separate note to the financial statements.

Investing activities involve

cash flows resulting from changes in investments and long-term asset items

Finally, the FASB encourages the use of the

direct method over the indirect method.

Operating activities involve

income statement items

A company reports the individual inflows and outflows from

investing and financing activities separately

operating is followed by

investing and then financing on the statement of cash flows

financing activities

involve liability and stockholders' equity items and include (a) obtaining cash from creditors and repaying the amounts borrowed, and (b) obtaining capital from owners and providing them with a return on, and a return of, their investment.

investing activities

involve long-term assets and include (a) making and collecting loans, and (b) acquiring and disposing of investments and productive long-lived assets.

The principal advantage of the indirect method is that

it focuses on the differences between net income and net cash flow from operating activities. That is, it provides a useful link between the statement of cash flows and the income statement and balance sheet.

The ..... activities section always appears first.

operating

Both IFRS and GAAP specify that companies must classify cash flows as

operating, investing, or financing.

If a company uses the direct method of reporting net cash flow from operating activities, the FASB requires that the company

provide in a separate schedule a reconciliation of net income to net cash flow from operating activities.

direct method

reports cash receipts and cash disbursements from operating activities. The difference between these two amounts is the net cash flow from operating activities. In other words, the direct method deducts operating cash disbursements from operating cash receipts. The direct method results in the presentation of a condensed cash receipts and cash disbursements statement.

indirect method

starts with net income and converts it to net cash flow from operating activities. In other words, the indirect method adjusts net income for items that affected reported net income but did not affect cash.

operating activities

the cash effects of transactions that enter into the determination of net income, such as cash receipts from sales of goods and services, and cash payments to suppliers and employees for acquisitions of inventory and expenses.

A company does not incorporate

these noncash items in the statement of cash flows.

cash outflows from operating activities

-to suppliers for inventory -to employees for services -to government for taxes -to lenders for interest -to others for expenses

The statement of cash flows provides information to help investors, creditors, and others assess the following:

1. The entity's ability to generate future cash flows. 2. The entity's ability to pay dividends and meet obligations. 3. The reasons for the difference between net income and net cash flow from operating activities 4. The cash and noncash investing and financing transactions during the period

significant noncash transactions that should be disclosed

1.Acquisition of assets by assuming liabilities (including capital lease obligations) or by issuing equity securities. 2.Exchanges of nonmonetary assets. 3.Refinancing of long-term debt. 4.Conversion of debt or preferred stock to common stock. 5.Issuance of equity securities to retire debt.

problems that arise with some frequency in the preparation of this statement include the following:

1.Adjustments to net income. 2.Accounts receivable (net). 3.Other working capital changes. 4.Net losses. 5.Significant noncash transactions.

The information to prepare the cash flows statement usually comes from three sources:

1.Comparative balance sheets 2.Current income statement data 3.Selected transaction data

preparing the statement of cash flows from the data sources involves three major steps:

Step 1. Determine the change in cash (difference between ending and beginning cash) Step 2. Determine the net cash flow from operating activities. (involves analyzing not only the current year's income statement but also comparative balance sheets as well as selected transaction data.) Step 3. Determine net cash flows from investing and financing activities (analyze all other changes in the balance sheet accounts to determine their effects on cash.)

If a company uses the indirect method, it can either report the reconciliation within the statement of cash flows or

can provide it in a separate schedule, with the statement of cash flows reporting only the net cash flow from operating activities.

Financing activities involve

cash flows resulting from changes in long-term liability and stockholders' equity items.

statement of cash flows reports

cash receipts, cash payments, and net change in cash resulting from a company's operating, investing, and financing activities during a period

The principal advantage of the direct method is that

it shows operating cash receipts and payments. Thus, it is more consistent with the objective of a statement of cash flows—to provide information about cash receipts and cash payments—than the indirect method, which does not report operating cash receipts and payments.