Textbook Notes (280,000)
CA (160,000)
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MGA (400)
Chapter 13

MGAB02H3 Chapter Notes - Chapter 13: Cash Flow Statement, Current Liability, Current Asset


Department
Financial Accounting
Course Code
MGAB02H3
Professor
Liang Chen
Chapter
13

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Chapter 13 Cash Flow Statement Notes
Reporting of Cash Flows
x comparative balance sheets show increase in PPE during year, but they do not show how the additions were financed or paid for
x statement of earnings shows net earnings, but it does not indicate the amount of cash generated or used by operating activities
x the statement of comprehensive income reports the changes in fair value of available-for-sale investments, but not the cash
generated from an investment once it is actually sold
x statement of shareholders’ equity shows cash dividends declared, but no the cash dividends paid during the year
Purpose of the Cash Flow Statement
x the main purpose of the cash flow statement is to provide information that enables its users to assess a company’s ability to
generate cash, and the needs of the company in using these cash flows
x the information reported in the cash flow statement includes the cash receipts, cash payments, and net changes in cash that result
from the operating, investing, and financing activities of a company during a specific period
x reporting the causes of changes in cash is useful because investors, creditors, and other interested parties want to know what is
happening to a company’s most liquid resource—its cash
x information in statement should help investors, creditors, and others assess following aspects of company’s financial position:
1. The reasons for the difference between net earnings and cash provided (used) by operating activities. Net earnings
provide information on the success or failure of a business. However, some people are critical of accrual-based net
earnings because these earnings require estimates, allocations, and assumptions. As a result, the reliability of net earnings
is sometimes doubted. Cash, in contrast, is often thought of as being different. If readers of the cash flow statement
understand the reasons for the difference between net earnings and net cash provided or used by operating activities, they
can decide for themselves how reliable the net earnings amount is.
2. The investing and financing transactions during the period. By examining investing and financing activities, a
financial statement reader can better understand why assets and liabilities increased or decreased during the period.
3. The company’s ability to generate future cash flows. Investors and others examine the relationship between items in
the cash flow statement. From these, they can better predict the amounts, timing, and uncertainty of future cash flows
than they can from accrual-based data.
Content of the Cash Flow Statement
Definition of Cash
x cash flow statement is often prepared using cash and cash equivalents as its basis rather than just cash
x cash equivalents are short-term, highly liquid investments that are readily convertible to cash within a very short period of time
x generally, only money-market instruments due within 3 months qualify by this definition, but sometimes short-term or demand
loans are also deducted from this amount; because of the varying definitions of “cash” that can be used in this statement,
companies must clearly define cash equivalents when they are included
x the International Accounting Standards Board and the Financial Accounting Standards Board are currently working on a project
to improve the presentation of information in certain financial statements, including the cash flow statement, which is more
commonly referred to as the statement of cash flows internationally
Classification and Reporting of Cash Flows
x statement classifies cash receipts and cash payments into 3 types of activities: (1) operating, (2) investing, and (3) financing
x transactions that are found within each type of activity include the following:
1. operating activities—cash flow activities from transactions which create revenues and expenses and therefore are
included in the determination of net earnings; they are affected by noncash items in the statement of earnings and changes
(increases or decreases) in noncash current asset and liability accounts in the balance sheet
2. investing activities—cash flow activities from short-term investments and long-term assets; these include (a) purchasing
and disposing of investments and long-lived assets and (b) lending money and collecting on those loans
3. financing activities—cash flow activities from short-term notes payable, long-term liability, and equity items; these
include (a) obtaining cash by issuing debt and repaying the amounts borrowed and (b) obtaining cash from shareholders
and providing them with a return on their investment
x internationally, companies currently have a choice as to whether to classify interest and dividends received (and paid) as either
an operating, investing, or financing activity, however, once the choice is made, it must be applied consistently
x most companies follow the same practice mandated in Canada, that is, interest and dividends received are classified as operating
activities and interest and dividends paid are classified as financing activities
x however, as financial statement presentation project currently under way is looking at the definitions of each of these activities to
better link them to the other financial statements, there may be further changes in the future
x in terms of today’s presentation requirements, cash flows are reported in 3 separate sections: operating, investing, and financing
x the section that reports cash flows from operating activities always appears first
x it is followed by the investing activities section and then the financing activities section
x note also that the individual inflows and outflows from investing and financing activities are reported separately
x thus, the cash outflow for the purchase of equipment is reported separately from the cash inflow from the sale of equipment
x similarly, the cash inflow from the issue of debt securities is reported separately from the cash outflow for the retirement of debt
x if a company did not report the inflows and outflows separately, some of the investing and financing activities would be hidden,
making it more difficult for the user to assess future cash flows
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Significant Noncash Activities
x in addition, it is important to recognize that not all of a company’s significant activities involve cash
x the following are examples of noncash activities:
1. issue of debt to purchase assets
2. issue of shares to purchase assets
3. conversion of debt into equity
4. exchange of property, plant, and equipment
x significant investing and financing activities that do not affect cash are not reported in the body of the cash flow statement,
however, these activities are reported in a note to the financial statements
Preparing the Cash Flow Statement
x cash flows from operating activities are shown first, followed by investing activities section and then financing activities section
x reported operating, investing, and financing activities result in net cash either provided or used by each activity
x amounts of net cash provided or used by each activity are totalled and result is net cash increase or decrease in cash for period
x this amount is then added to or subtracted from the beginning-of-period cash balance to obtain the end-of-period cash balance
x the end-of-period cash balance should agree with the cash balance reported on the balance sheet
x first, it is not prepared from an adjusted trial balance—the statement requires detailed information about the changes in account
balances that occurred between two periods of time; an adjusted trial balance will not provide the necessary data
x second, statement deals with cash receipts and payments—accordingly, accrual concept is not used in preparation of statement
x the information to prepare this statement usually comes from three sources:
1. The comparative balance sheet indicates the amounts of the changes in assets, liabilities, and shareholders’ equity from
the beginning of the period to its end.
2. The statement of earnings helps the reader determine the amount of cash provided or used by operating activities during
the period.
3. Additional information includes transaction data that are needed to determine how cash was provided or used during the
period. We will also use selected information from the statement of comprehensive income and statement of
shareholders’ equity to help us complete the cash flow statement and the notes to the financial statements.
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