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Accounting Principles II – Statement of Cash Flows

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Study GuideAccounting PrinciplesII–Statement of Cash Flows1.Statement SectionsWhy Cash Management MattersCash management is a key part of running any business. A company must knowhow much cash itexpects to receiveandhow much cash it needs to pay out. This information helps managersdecide whether the business has extra cash to invest or whether it will need more cash to cover dailyneeds—such as paying employees or suppliers.What Is the Statement of Cash Flows?Thestatement of cash flowsis a financial statement that showshow cash and cash equivalentsmove in and out of a businessover a specific period of time.Cash equivalentsare short-term, highly liquid investments that usually mature withinthree monthsof purchase. Common examples include:•U.S. Treasury bills•Money market funds•Commercial paperThroughout this chapter, the word“cash”meanscash plus cash equivalents.1.Main Sections of the Statement of Cash FlowsThe statement of cash flows is divided intofour main sections:1.Operating activities2.Investing activities3.Financing activities4.Cash reconciliation

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Study GuideThe first three sections explainwhere cash came from and how it was used, while the fourthsection showshow total cash changed during the period.2.Format of the Statement of Cash FlowsLike all financial statements, the statement of cash flows begins with athree-line heading:•Name of the company•Name of the statement•Time period covered (such as a month, quarter, or year)3.Operating ActivitiesWhat Are Operating Activities?Theoperating activitiessection comes first. It shows whether the company generated enough cashfrom itsnormal, day-to-day business operations.Typical operating cash flows include:•Cash collected from customers•Payments to employees and suppliers•Payments for operating expenses

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Study Guide•Payments for taxes•Interest received•Dividends received•Interest paidThere aretwo acceptable methodsfor reporting operating activities. These methods are explainedlater in the section titled“Preparing the Statement of Cash Flows.”4.Investing ActivitiesPurpose of Investing ActivitiesTheinvesting activitiessection shows how a company uses cash togrow or maintain itsbusiness. It focuses on changes inlong-term assets.This section includes cash transactions related to:•Land•Buildings•Equipment•Intangible assets•Investments (excluding cash equivalents)Special Note on Notes Receivable•If anote receivablecomes from selling goods or services to a customer, cash collected isreported as anoperating activity.•If the note was created for another purpose, the cash collected is reported as aninvestingactivity.Common investing activities include:

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Study Guide•Buying and selling equipment•Buying and selling securities•Making loans and collecting loan repayments5.Financing ActivitiesWhat Financing Activities ShowThefinancing activitiessection explainshow the company pays for its operations and growth. Itreports changes in:•Long-term liabilities•Stockholders’ equityTypical financing activities include:•Borrowing money•Repaying loans•Issuing company stock•Paying dividends•Repurchasing company stock6.Reporting Cash Inflows andOutflows SeparatelyIn both theinvestingandfinancingsections, each cash inflow and outflow must be reportedseparately.For example:•If equipment is sold for $7,000 and new equipment is purchased for $50,000, bothtransactions are listed separately.•If the company borrows $1,000,000 and repays $150,000 during the same period, eachtransaction is shown individually.

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Study Guide7.Cash ReconciliationHow Cash Is ReconciledThecash reconciliationsection is the final part of the statement. It explains how cash changed fromthe beginning to the end of the period.The process works like this:1.Start with thenet increase or decrease in cash, calculated from operating, investing, andfinancing activities.2.Add thebeginning cash balance.3.The result is theending cash balance.The ending cash balance must match thecash reported on the balance sheetat the end of theperiod.

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Study GuideNon-Cash TransactionsSome important business activities do not involve cash. Thesenon-cash transactionsarenotincludedin the statement of cash flows. However, if they are significant, they must be disclosed:•Below the statement, or•In the notes to thefinancial statements2. Preparing the Statement of Cash FlowsTo prepare a statement of cash flows, accountants can chooseone of two acceptable methods:1.TheDirect Method2.TheIndirect MethodThedifference between these two methods appears only in the operating activities section.Even though the format is different,both methods always result in the same total cash providedby operating activities.Overview of the Two MethodsBoth methods report:•Cash fromoperating activities•Cash frominvesting activities•Cash fromfinancing activitiesHowever, they explainoperating cash flowsin different ways.

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Study Guide1.Direct MethodWhat Is the Direct Method?Thedirect methodreports cash flows bylisting actual cash receipts and cash paymentsrelatedto daily business operations.Instead of starting with net income, this method focuses onwhere cash actually came from andwhere it went.Common Cash Inflows and OutflowsUnder the direct method, operating activities include:•Cash collected from customers•Cash paid to suppliers•Cash paid for operating expenses•Cash paid for interest

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Study Guide•Cash paid for income taxesThese clear labels make the statementeasy to read and easy to understand, especially forstudents and non-accountants.2.Indirect MethodWhat Is the Indirect Method?Theindirect methodbegins withnet incomefrom the income statement.It then adjusts net income to convert it from anaccrual basisto acash basis.Why Most Companies Use the Indirect MethodAlthough theFinancial Accounting Standards Board (FASB)prefers the direct method, mostcompanies choose the indirect method because:•It iseasier to prepare•It revealsless detailed informationto competitorsAdjustments Made Under the Indirect MethodNet income is adjusted for:•Non-cash expenses, such as depreciation and amortization•Gains and lossesfrom asset sales•Changes in current assets and current liabilitiesExamples of common adjustments:•Depreciation expense isadded back•A loss on sale of equipment isadded back•Increases and decreases in working capital accounts are adjusted to reflect actual cash flow

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Study GuideUsing Financial Statements to Prepare the Cash Flow StatementTo demonstrate both methods, information fromBrothers’ Quintet, Inc.is used. The followingfinancial statements provide the data needed.Balance Sheets (20X1 and 20X0)

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Document Details

University
Texas A&M University
Course
Accounting Principles II
Subject
Accounting

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