Chapter 13 Notes

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University of Toronto Scarborough
Financial Accounting
Liang Chen

Chapter 13 Cash Flow Statement Notes Reporting of Cash Flows N comparative balance sheets show increase in PPE during year, but they do not show how the additions were financed or paid for N statement of earnings shows net earnings, but it does not indicate the amount of cash generated or used by operating activities N 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 N statement of shareholders equity shows cash dividends declared, but no the cash dividends paid during the year Purpose of the Cash Flow Statement N the main purpose of the cash flow statement is to provide information that enables its users to assess a companys ability to generate cash, and the needs of the company in using these cash flows N 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 N reporting the causes of changes in cash is useful because investors, creditors, and other interested parties want to know what is happening to a companys most liquid resourceits cash N information in statement should help investors, creditors, and others assess following aspects of companys 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 companys 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 N cash flow statement is often prepared using cash and cash equivalents as its basis rather than just cash N cash equivalents are short-term, highly liquid investments that are readily convertible to cash within a very short period of time N 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 N 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 N statement classifies cash receipts and cash payments into 3 types of activities: (1) operating, (2) investing, and (3) financing N transactions that are found within each type of activity include the following: 1. operating activitiescash 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 activitiescash 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 activitiescash 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 N 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 N 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 N 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 N in terms of todays presentation requirements, cash flows are reported in 3 separate sections: operating, investing, and financing N the section that reports cash flows from operating activities always appears first N it is followed by the investing activities section and then the financing activities section N note also that the individual inflows and outflows from investing and financing activities are reported separately N thus, the cash outflow for the purchase of equipment is reported separately from the cash inflow from the sale of equipment N similarly, the cash inflow from the issue of debt securities is reported separately from the cash outflow for the retirement of debt N 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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