22.1: Purpose, Uses, and Importance of Cash, Cash Equivalents, and Cash flows Flashcards
What is the primary purpose of the statement of cash flows?
The primary purpose is to provide information about an entity’s cash receipts and cash payments during a period.
It focuses on cash flows from operating, investing, and financing activities.
What is the secondary objective of the statement of cash flows?
The secondary objective is to provide information about changes in cash and cash equivalents, enabling users to assess an entity’s liquidity, financial flexibility, and cash solvency.
Why is the statement of cash flows less susceptible to earnings management than the statement of comprehensive income?
The statement of cash flows is based on actual cash transactions and is less affected by accrual-based items, such as inventory obsolescence and restructuring costs, which are more subjective.
What are the key questions answered by the statement of cash flows?
It answers questions about a company’s ability to:
Pay dividends,
Finance acquisitions,
Meet debt obligations,
Fund expansion,
Show cash inflows from bonds or plant/equipment financing.
According to Underlying Concept 22.1, what is the significance of the statement of cash flows?
The statement of cash flows is essential for assessing and predicting future cash flows, providing relevant information for decision-making.
What are the three main uses of cash flow information by investors and creditors?
Assessing liquidity and solvency of the entity.
Analyzing amounts, timing, and uncertainty of future cash flows.
Understanding the difference between net income and cash flow from operating activities.
What does liquidity refer to in the context of the statement of cash flows?
Liquidity refers to the entity’s capacity to generate cash to meet obligations, increase productive capacity, and distribute returns to owners.
How does cash flow information help predict future cash flows?
By examining relationships between sales, net income, and cash flows from operating activities, and comparing cash flow changes with cash and cash equivalents.
Why is it important to know the difference between net income and cash flow from operating activities?
Because net income often includes non-cash estimates, while cash flows represent actual cash available, providing better insight into a company’s financial health and operational performance.
How is “cash” defined in financial reporting?
Cash is defined as cash on hand and demand deposits.
What are “cash equivalents”?
Cash equivalents are short-term, highly liquid investments that are readily convertible to known amounts of cash and have an insignificant risk of changes in value.
What types of investments typically qualify as cash equivalents?
Cash equivalents include non-equity investments such as treasury bills, commercial paper, and money market funds, generally acquired with maturities of three months or less.
How does ASPE treat bank overdrafts in relation to cash and cash equivalents?
Under ASPE, bank overdrafts repayable on demand that are part of a banking arrangement are included in cash and cash equivalents.
What is Underlying Concept 22.2 regarding the term “cash equivalents”?
Underlying Concept 22.2 explains that the FASB and IASB considered discontinuing the use of the term “cash equivalents,” suggesting all non-cash securities be classified as short-term investments.
However, this project was paused, and no changes were implemented.
How does IAS 7 treat certain types of short-term investments in relation to cash equivalents?
IAS 7 allows certain non-equity investments, such as preferred shares acquired close to their maturity date, to be included as cash equivalents.
