MGTB06 Chapter 5 Notes.docx

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Department
Financial Accounting
Course
MGAB02H3
Professor
G.Quan Fun
Semester
Winter

Description
lMGTB06 Chapter 5—Reporting and Interpreting Cash Flows Classification of Cash Flows the statement of cash flows explains how the cash balance at the beginning of the period changed to another cash balance at the end of the period cash includes cash and cash equivalents which are short-term, highly liquid investments with an original maturity of less than three months (little risk that their value will change if interest rates changes) Cash Flows from Operating Activities cash flows from operating activities are cash inflows and outflows directly related to earnings (revenues and expenses) from normal operations 1. direct method of presenting the operating activities section of CF reports components of cash flows from operating activities as gross receipts (inflows) and gross payments (outflows) 2. indirect method of presenting the operating activities section of CF adjusts (non-cash items) profit to compute cash flows from operating activities cash flows from operating activities is always the same whether it is computed by using the direct or indirect method Cash Flows from Investing Activities cash flows from investing activities are cash inflows and outflows related to the acquisition or sale of productive facilities and investments in the securities of other companies Cash Flows from Financing Activities cash flows from financing activities are cash inflows and outflows related to external sources of financing (owners and creditors) for the enterprise Net Increase (Decrease) in Cash combination of the net cash flows from operating, investing and financing activities must equal the net increase (decrease) in cash for the reporting period Relationship to the Statement of Financial Position and the Income Statement to prepare cash flows comparative statements of financial position, complete income statement and additional details are needed (analysis of individual accounts is necessary because often the net change in an account balance during the year does not reveal the underlying nature of cash flows) Assets = Liabilities + Shareholders’ Equity Δ Cash = Δ Liabilities + Δ Shareholders’ Equity – Δ Non-Cash Assets any transaction that changes cash must be accompanied by a change in liabilities, shareholders’ equity or non-cash assets financial position accounts operating activities are most current assets (other than short-term investments), most current liabilities (other than amounts owned to investors and financial institutions) and retained earnings for profit (split between operating and financing) investing activities are remaining assets on statement of financial position (investments and capital assets) financing include all of remaining liability and shareholders’ equity account (share capital, retained earnings for dividends, bank borrowings) Reporting and Interpreting Cash Flows from Operating Activities A Simplified Illustration under indirect method: given that revenue and expenses include both cash and non-cash components, we need to remove the non-cash revenues and expenses from profit to obtain the cash components Cash Elements = Profits ± Non-Cash Elements Reporting Cash Flows From Operating Activities—Indirect Method general structure if operating activities section: Profit ± (Non-Cash Expenses, Decreases/Increases in Non-Cash CA and CL) when converting profit to cash flows from operating activities: add a change when the CA decreases or CL increases and subtract the chance when a CA increases and CL decreases change in trade receivables—the income statement reflects the revenue of the period but cash from OA must reflect cash collections from customers, if there is an increase in A/R that means cash collected from customers is lower than revenue so this difference must be subtracted from profit change in inventory—income statement reflects merchandise sold while cash flow from OA reflect cash purchase, if there is a net increase in inventory that means that the cost of purchases is larger than the cost of merchandise sold so this increase must be subtracted from profit change in prepayments—income statement reflects expenses of period but cash flow from OA reflects cash payments, if prepayments increases that means amount of expenses is less than new cash prepayments so this difference must be subtracted from profit change in trade payables—cash flow from operations must reflect cash purchases, if trade payables increases that means cash payments were less than purchases on account so this increase must be added to profit change in
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