Module 4--Statement of Cash Flows and Shareholder's Equity Flashcards
What are the PURPOSES of the STATEMENT of CASHFLOWS?
Purposes of the Statement of Cash Flows
A company must be able to generate cash to survive. Net income is NOT equal to cash flow. The statement of cash flows (aka cash flow statement) explains the change during the period in cash and cash equivalents. The statement of cash flows, along with the balance sheet and the income statement, provides a comprehensive view of the company’s financial situation. The purposes of the statement of cash flows are to:
■ Assess the company’s ability to generate cash
■ Assess the company’s ability to meet financial obligations or pay dividends
■ Identify potential needs for additional financing
■ Identify the difference between net income and cash flows
* Statement of cash flows is prepared using cash accounting while the income statement uses accrual accounting.
* A company may be profitable and still go bankrupt if cash flows are unable to meet current liabilities as they become due.
■ Assess the effect of cash and noncash investing and financing transactions
Is NET Income the same as CASH FLOW?
IS NOT equal to cash flow, bc depreciation is not taken into account.
What are the TWO METHODS of REPORTING CASH FLOWS?
■ There are two methods of reporting cash flows.
* Direct method – procedure for recording all cash transactions, inflows and outflows for the year
- Indirect method – procedure for adjusting net income for those items that do not affect cash flow from an accrual method to a cash basis
What are the three categories the methods divide CASH FLOWS into?
■ Each method divides cash flows into three categories: OPERATING, INVESTING and FINANCING. The only difference in the two methods is the operating section.
How would CASH FLOW TRANSACTIONS look like if we used the DIRECT METHOD of Accounting?
Five Major Groups of Accounts Three Categories
(Balance Sheet & Income Statement) (Statement of Cash
Flow)
Revenue / Sales Expenses <———————–> Operating
Assets <----------------------> Investing
Liabilities/Equity <---------------------> Financing
What is the INDIRECT METHOD
Indirect Method
For operating activities:
■ The indirect (or reconciliation) method starts with net income.
* For investing and finance activities, these sections are identical to the direct method.
■ Noncash items, such as depreciation, amortization, impairment and accruals, are added back to net income.
■ Changes in the other accounts either are positive or negative for cash flow and are shown in the indirect method.
What are OPERATING ACTIVITIES?
Operating Activities
Operating activities are any activities related to producing and delivering goods or providing services. It is critical that companies have a positive cash flow from operations; cash received must be larger than cash paid out for operations.
■ Operating cash inflows include cash receipts
* From sale of goods or services
* From collection of revenue through customer accounts or notes receivable
* From interest income on loans or dividend income on investments
* All cash receipts not classified under investing or financing receipts
■ Operating cash outflows include cash payments
* To acquire materials to produce goods or to acquire goods to be resold
* Of accounts payable or notes payable to suppliers
* To employees
* To governments for taxes, duties, fines or other fees
* To lenders or creditors (for interest expense)
* All other cash payments not classified as investing or financing payments
What are INVESTING ACTIVITIES?
Investing Activities
■ Cash inflows include cash received from the sale of:
* Property, plant or equipment
* Company loans or debt instruments of others
* Equity securities of others
■ Investing cash outflows include cash paid:
* To acquire equity securities of other companies
* To acquire debt instruments of other companies
* For purchase of plant, property, equipment or other productive assets
What are FINANCING ACTIVITIES?
Financing Activities
Financing activities include obtaining resources from owners and providing them with a return on (and return of) their investment. Additionally, financing activities involve borrowing money and repaying amounts borrowed. The purchase of treasury stock by the company is included in this category.
■ Financing cash inflows includes cash from:
* Issuing equity securities of own company
* Issuing debt securities of own company
* Borrowing money from banks
■ Financing cash outflows includes company’s:
* Cash payment of dividends or other distributions to owners from retained earnings
* Cash repayment of the principal of debt
* Purchase of treasury stock
What are the PURPOSES of the STATEMENT of SHAREHOLDERs’ EQUITY?
Purposes of the Statement of Shareholders’ Equity
The statement of shareholders’ equity is a financial statement that shows the same basic information as the statement of retained earnings, but also shows the changes in all shareholders’ equity accounts. There are several purposes:
■ Reflect changes in equity section of balance sheet
■ Identify number of shares of treasury stock
■ Identify cash dividends declared
■ Identify number of shares outstanding and new shares issued
■ Show proceeds from stock issued
■ Meet FASB requirements
What is COST of GOODs SOLD (COST of SALES)
Cost of goods sold includes raw materials, factory direct labor and factory overhead.
Factory overhead includes utilities, rent, depreciation and indirect labor.
■ Two sources
* Goods manufactured
* Goods purchased for resale (retailer)
Differences in Inventory Accounting (Cost of Goods Sold)
Tax rules require use of the same inventory method for taxes and financial reporting. MaxProf Co. foregoes tax savings to get higher income to report to shareholders.
Differences in Depreciation?
Differences in Depreciation
For shareholder purposes, a company can use any one of several depreciation methods; for tax purposes, the company must use the Modified Accelerated Cost Recovery System (MACRS) specified in the Internal Revenue Code (IRC). It is about half-way between double-declining balance and straight-line.
MaxProf Co’s use of partial year depreciation in the year of purchase of the assets is known as the “half-year convention.”
Other Possible Differences
Discuss the following questions as a group to become more familiar with other possible accounting differences.
1. On what basis should allowances for doubtful accounts be determined?
2. What flexibilities do companies have when reporting write-offs?
3. What flexibilities exist when reporting defined benefit pension plans?
4. What flexibilities exist when reporting stock issued to employees?
- What is a purpose of the statement of cash flows?
A. To increase the ability for a company to generate cash
B. To identify the difference between net income and cash flows
C. To disclose the company’s amount of profit/loss
D. To determine values for sales incentive/bonus plans
B. To identify the difference between net income and cash flows
