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Lecture 13

ACCT 2220 Lecture Notes - Lecture 13: Cash Flow Statement, Cash Cash, Accrual


Department
Accounting
Course Code
ACCT 2220
Professor
Louise Hayes
Lecture
13

Page:
of 4
Accounting Chapter 13:
Cash Flow Statement
Study Objectives:
1. Describe the purpose and content of the statement of cash flows.
2. Prepare the operating activities of a statement of cash flows using one of two
approaches: (a) the indirect method or (b) the direct method.
3. Prepare the investing activities section of a statement of cash flows.
4. Prepare the financing activities section of a statement of cash flows.
5. Complete the statement of cash flows.
6. Use the statement of cash flows to evaluate a company’s liquidity and solvency.
Purposes of the Statement of Cash Flows
Helps users assess:
- A company’s ability to generate cash
- What the company did with the cash
This is useful in determining:
- Company’s ability to generate future cash flows
- Investing and financing transactions during the period, and effect upon capital
structure
- Making comparisons with other companies
Definition of Cash Classification of Cash Flows
Cash may include cash equivalents
- Short-term, highly liquid trading investments that are readily converted to cash
within a short period of time (usually within three months)
Cash receipts and payments are classified into three categories:
- Operating activities
- Investing activities
- Financing activities
Operating Activities
Cash effects of transactions that create revenues and expenses that enter into
determination of profit. Includes relevant noncash current assets and current liabilities
on the statement of financial position – where the related account is an income
statement account.
Investing Activities
Purchasing and Disposing of:
- Long term investments not held for trading
- Long-lived assets
Lending money and collecting the loans. Generally includes non-current asset items
(long-lived investments, property, plant and equipment) on the statement of financial
position.
Financing Activities
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- Obtaining Cash from issuing debt and repaying the amounts borrowed
- Obtaining Cash from selling common and preferred shares and paying dividends
- Generally includes non-current liabilities, and shareholders’ equity items
Significant Noncash Activities
If it does not affect cash, do NOT report it in the statement of cash flows. You would
report it in separate note to the financial statements. Examples:
- Issue of debt to purchase assets
- Issue of shares to purchase assets
- Conversion of debt into equity
- Exchange of property, plant and equipment
Format of Cash Flow Statement
Operating Activities
Investing Activities
Financing Activities
Net Increase (Decrease) in Cash
Cash, beginning of period
Cash, end of period
Preparing the Statement of Cash Flows
Step 1: Operating Activities
- Determine the net cash provided (used) by operating activities by converting
profit from an accrual basis to a cash basis
- Conversion may be done by either the indirect or direct method; both methods
arrive at the same amount of net cash provided (used) by operating activities
- Most companies favour the indirect method because it is easier to prepare and it
reveals less information to competitors
Indirect Method
- Start with profit and add or deduct items not affecting cash to arrive at net cash
provided (used) by operating activities
+ Non-cash expenses such as depreciation and losses
- Noncash revenues and gains
+ Decreases in noncash current asset accounts and increases in noncash
current liability accounts
- Increases in noncash current asset accounts and decreases in noncash current
liability accounts
Direct Method
- Standard setters prefer the direct method but allow the use of either method
- Details cash receipts and payments
- Similar to indirect method:
Adjusts income statement from accrual basis to cash basis in order to arrive at net
cash provided (used) by operating activities. However, whereas indirect method
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adjusts total profit, direct method adjusts each individual revenue and expense
account.
Cash Receipts from Customers
The relationship among cash receipts from customers, revenues from sales, and
changes in accounts receivable is:
Cash receipts from customers = Revenue (+decrease in accounts receivable or –
increase in accounts receivable)
If other cash receipts (such as interest) these may be adjust for any receivable
amounts as was done above.
Cash Payments to Suppliers
The relationship among cash payments to suppliers, cost of goods sold, changes in
inventory and changes in accounts payable is:
Cash Payments to Suppliers = Cost of Goods Sold (+increase in inventory or –
decrease in inventory (+decrease in accounts payable or –increase in accounts
payable)
Cash Payments for Operating Expenses
The relationship among cash payments for operating expenses, changes in prepaid
expenses and changes in accrued expenses payable is:
Cash Payments for operating Expenses = Operating Expenses (+increase in
Prepaid expenses or –decrease in prepaid expenses (+decrease in accrued
expenses payable or –increase in accrued expenses payable)
Cash Payments for Income Tax
The relationship among cash payments for income tax, income tax expense, and
changes in income tax payable is:
Cash Payments for income tax = income tax expense (+decrease in income tax
payable or –increase in income tax payable
- A similar calculation would be made for cash payments for interest
Step 2: Investing Activities
- Measure cash flows relating to non-current asset accounts; long-term
investments; property, plant and equipment; intangible assets
- Reported the same under both direct and indirect methods
- Asset acquisitions are uses of cash; disposals are source of cash (for the
proceeds of disposition)
- Depreciation is a noncash charge
Step 3: Financing Activities
- Determine the net cash provided (used) by financing activities by analyzing
changes in non-current liability and shareholders’ equity accounts
- Changes to notes, loans, and bonds payable are analyzed to determine cause of
change; amortization of premium or discount (if any) are noncash charges and
have no effect
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