22.7: Preparing a statement of cash flows using both methods Flashcards
What is the difference between the direct and indirect methods for preparing a Statement of Cash Flows?
Indirect Method: Begins with net income and adjusts for changes in working capital, non-cash items (depreciation, amortization), and other gains or losses to reconcile with operating cash flow.
Direct Method: Lists cash inflows and outflows directly, including cash received from customers and cash paid to suppliers and employees. This method is generally considered more detailed.
What are the steps involved in preparing a Statement of Cash Flows using the indirect method?
Start with Net Income: Begin with the reported net income from the income statement.
Adjust for Non-Cash Items: Add back non-cash expenses like depreciation, amortization, and impairment losses.
Adjust for Gains and Losses on Investments: Subtract gains or add back losses related to the sale of investments or fixed assets.
Adjust for Changes in Working Capital: Include changes in current asset and liability accounts such as accounts receivable, inventory, and accounts payable.
Final Operating Cash Flow: After all adjustments, calculate the final net cash provided by (or used in) operating activities.
How does the direct method list cash inflows and outflows?
Cash Receipts from Customers: Reflects all cash inflows from sales to customers.
Cash Paid to Suppliers and Employees: Reflects cash outflows for operating expenses such as inventory purchases, wages, and overhead.
Operating Activities Total: Results in net cash provided by (or used in) operating activities without starting from net income.
What are common adjustments for non-cash items in the indirect method?
Depreciation and Amortization: Added back because these expenses reduce net income but don’t involve cash.
Impairment Losses: Added back as these are non-cash losses affecting net income.
Amortization of Bond Discounts/Premiums: Adjusted to reflect bond-related cash flow differences.
Deferred Income Taxes: Added back or subtracted depending on tax timing differences.
How do you adjust for changes in working capital in the indirect method?
Accounts Receivable: A decrease is added back (cash was received), and an increase is subtracted (cash not yet received).
Inventory: A decrease is added back (cash not spent), and an increase is subtracted (cash spent on purchases).
Accounts Payable: An increase is added back (cash not yet paid), and a decrease is subtracted (cash was used to pay suppliers
What adjustments are made for gains or losses on investments in the indirect method?
Gains on Sale of Assets or Investments: These gains are subtracted from net income as they are part of investing, not operating activities.
Losses on Sale of Assets or Investments: These losses are added back to net income, similar to gains, as they do not involve cash outflow in operations.
How are dividends and interest treated under IFRS and ASPE for cash flow reporting?
IFRS: Dividends paid and interest received can be classified as either operating or financing activities, depending on the company’s policy.
ASPE: Dividends and interest paid must be classified as financing activities.
How does a company adjust for the sale or purchase of investments in the cash flow statement?
Sale of Investments: Proceeds from sales are added to investing activities as a cash inflow.
Purchase of Investments: Cash spent on acquiring investments is subtracted from investing activities as a cash outflow.
How do deferred taxes and amortization affect cash flow reporting?
Deferred Taxes: The movement in deferred taxes is adjusted as they reflect timing differences between accounting and tax reporting.
Amortization of Intangibles (e.g., Deferred Development Costs): Amortization is a non-cash expense and is added back to net income in the indirect method.
How are term preferred shares and common shares treated in the cash flow statement?
Issuance of Shares: Proceeds from the issuance of shares (common or preferred) are considered a financing activity and added as a cash inflow.
Repurchase of Shares: Payments made to repurchase shares are treated as financing outflows and subtracted from financing activities.
