Week 6

Question 1

What is the purpose of the statement of comprehesive income and statement of cash flows?

Answer 1

• Statement of comprehensive income measures economic performance
• Statement of cash flows speaks to the capacity of a business to generate cash and the business’ need for cash resources.

Question 2

What is bankruptcy?

Answer 2

State of being unable to pay your bills when they are due.

Question 3

What are cash and cash equivalents?

Answer 3

• Cash: cash on hand and demand deposts
• Cash equivalents: short-term highly liquid investments that are readily convertible to known amounts of cash and subject to an insignificant risk of changes in value.

Question 4

What is required to be considered a cash equivalent?

Answer 4

Must meet the convertibility and insignificant risk tests.

• Cash equivalents are short term investments that are readily convertible to known amounts of cash, and are very unlikely to change in value.
• Usually only investments with maturities of 3 months or less meet the criteria.
• Overdrafts are cash equivalents
• Foreign currency can be (if it qualifies)

Question 5

Cash flows arise from which 3 activities?

Answer 5

1. Operating activities
2. Investing activities
3. Financing activities

Question 6

What are operating activities?

Answer 6

Principal revenue producing activities of the entity and other activities that are not investing or financial activities.

Think current assets and liabilities

Examples:

• Cash receipts from the sale of goods and rendering of services
• Cash receipts from royalties, fees, commissions, and other revenue
• Cash payments to suppliers for goods and services
• Cash payments to employees
• Cash payments or refunds of income taxes unless they can be specifically identified with financing and investing activities

Question 7

Where are securities held for trading (investments in financial assets at FVPL) classified in statement of cash flows?

Answer 7

Operating activities

• This is provided that the security has not be classified as a cash equivalent
• Add amount received from sale investments classified as FVPL (not in cash equivalents)
• Subtract amount paid to acquire investments classified as FVPL (not in cash equivalents)

Question 8

What are investing activities?

Answer 8

Activities that include the purchase and sale of long-term assets and other investments that do not quality as cash equivalents. Generally consist of transactions that result in cash inflows or outflows related to resources used for generating future income and cash flows.

Think non-current assets

Examples:

• Cash payments to acquire property, plant and equipment (PPE) (use of cash)
• Cash receipts from sales of PPE (source of cash)
• Cash payments to acquire investments in debt and equity securities (other than cash equivalents or reported at FVPL) (use of cash)
• Cash receipts from sales of investments in debt and equity securities (other than cash equivalents or reported at FVPL) (source of cash)

Question 9

What are financing activities?

Answer 9

Activities that result in changes in the size and composition of a company’s contributed equity and borrowings.

Think non-current liabilities

Examples:

• Cash proceeds from issuing shares or other equity instruments (source of cash)
• Cash payments to acquire or redeem the entity’s shares (use of cash)
• Cash proceeds received from loans, notes, bonds, mortgages and other short-term or long-term borrowings (source of cash)
• Cash repayments of the principal amounts borrowed (use of cash)
• Cash payments by a lessee for the principal reduction of the outstanding liability relating to a finance lease (use of cash)

Question 10

Where are interest and dividends classified on statement of cash flows?

Answer 10

Receipt of interest and dividends -> operating or investing activity

Payment of interest and dividends -> operating or financing activity

• Decision must be applied consistently for similar transactions.

Question 11

Where are income taxes classified on statement of cash flows?

Answer 11

Operating, Investing, or Financing

• Generally operating unless the transaction is identified with financing or investing activities

Question 12

Are investing and financing activities not involving cash included in statement of cash flows?

Answer 12

No

Material non-cash transactions are disclosed on the financial statements.

Examples:

• Exchanges of shares or debt for assets or settlement of liabilities
• Conversion of debt to shares
• Stock splits and stock dividends

Question 13

How are activities on statement of cash flows reported.. using direct or indirect methods?

Answer 13

• Operating: direct (encouraged) or indirect (done by 95%)
• Investing: direct
• Financing: direct

Note: total cash generated for operating activites is the same with direct and indirect methods

Question 14

What is the starting point for the indirect method?

Answer 14

Profit or loss

Question 15

What does an accountant need to prepare the statement of cash flows?

Answer 15

• Statement of comprehensive income for the period
• Comparative statement of financial position
• Select transactional data

Question 16

What is happening when you are using the indirect method?

Answer 16

Mechanical process that systematically converts the company’s accrual-based income statement to a cash-based statement.

Question 17

What is the procedure for the indirect method?

Answer 17

1. Establish change in cash for the period that needs to be reconciled by comparing closing cash balance to previous cash balance (look at comparative statement of financial position)
2. Start with net income (net loss) and adjust items to determine net cash from operating activities:
   
   • Add back non-cash expenses and losses, such as depreciation
   • Subtract non-cash revenues and gains
   • Add back interest and income tax expense and subtract investment income.
   • Adjust for changes in working capital accounts. Cash inflow: decrease in current asset, increase in current liability. Cash outflow: increase in current asset, decrease in current liability
   • Add amount received from sale investments classified as FVPL (not in cash equivalents)
   • Subtract amount paid to acquire investments classified as FVPL (not in cash equivalents)
   • Add interest and dividends received and subtract interest, dividends and income taxes paid (if so classified)
   • The sum of the above equals net cash from (used in) operating activities for the period.
3. Account for remaining unexplained discrepancies in the statement of financial position. Recorded in financing or operating activities.
4. Complete the statement of cash flows by calculating subtotals for the 3 activities and ensuring the sum of the change in cash equals the actual change as determined in step 1.

Question 18

How is interest paid calculated in statement of cash flows?

Answer 18

Interest paid = interest expense +/ change in interest payable

If interest payable increases, then “-“ (it would be a source of cash)

Question 19

How is dividends paid calculated in statement of cash flows?

Answer 19

Dividends paid = dividends declared +/ change in dividends payable

If dividends payable increases, then “-“ (it would be a source of cash)

Question 20

How is income tax paid calculated in statement of cash flows?

Answer 20

Income tax paid = sum of current and deferred income tax expense +/ sum of the change in current and deferred income taxes payable

If income taxes payable increases, then “-“ (it would be a source of cash)

Question 21

How is closing retained earnings calculated in statement of cash flows?

Answer 21

Opening retained earnings +/ net income (loss) - dividends declared = closing retained earnings

Question 22

What is the direct method of determining cash flows from operating activities?

Answer 22

Where all cash receipts and cash payments from operating activities are reported.

Consider the following:

1. Cash from customers
2. Cash for COGS + operating expenses
3. Cash paid for interest
4. Cash paid for taxes

Question 23

What is the calculation for cash receipts from customers using the direct method for operating expensives?

Answer 23

cash receipts from customers

= sales +/ change in accounts receivable +/ change in unearned revenue

= sales +/- change in gross accounts receivable - write offs +/ change in unearned revenue

= change in net receivables - bad debt expense +/ change in unearned revenue

• If receivables increases, then “-“ (use of cash)
• If unearned or deferred revenue increases, then “+” (source of cash)

Question 24

What is the calculation for cash paid for purchases from customers using the direct method for operating expensives?

Answer 24

Cash paid for purchases

= COGS +/ change in inventory

• If inventory increases, then “+” (use of cash)

Adding it all up…

Cash paid to suppliers and employees = Opening payables + Purchases + Expenses –Closing payables

Question 25

What is the calculation for cash paid for inventory from customers using the direct method for operating expensives?

Answer 25

cash paid for inventory (suppliers)

= purchases +/- change in accounts payable

= COGS +/ change in inventory +/- change in accounts payable

• If accounts payable increases, then “-“ (source of cash)

Question 26

What is the calculation for cash paid for operating expenses using the direct method for operating expensives?

Answer 26

cash paid for operating expenses = operating expenses +/ change in prepaid expenses

• If prepaid expenses increases, then “+” (use of cash)

Question 27

What is the calculation for cash paid to employees using the direct method for operating expensives?

Answer 27

cash paid to employees = salaries expenses +/ change in salaries payable

• If salares payable increases, then “-“ (source of cash)

Question 28

Where are discontinued operations reported?

Answer 28

• Separated reported in statement of cash flows; or
• In notes to the financial statements

Question 29

How are investments in joint ventures or associates reported on statement of cash flows?

Answer 29

• With indirect method: reported income from associate or joint venture must be deducted as an adjustment to net income in the operating section
• Dividends (direct or indirect): must be reported as a cash inflow in either operating or investing

Question 30

How are unrealized gains and losses in investments at FVPL reported on statement of cash flows?

Answer 30

Must be subtracted from net income/added back to net income in the operating section.

Question 31

Why is depreciation expense included in the statement of cash flows and which sign does it take?

Answer 31

Since depreciation is an expense subtracted from revenue to get net income, but it doesn’t actually affect cash, it is added back to operating activities in the statement of cash flows. (+)

Question 32

How are gains and losses on the sale of investing activities handled on the statement of cash flows?

Answer 32

• Gains are subtracted
• Losses are added

Similiar to depreciation expense, the gain was already added to net income so it must be subtracted from the statement of cash flows from operating activities.

Question 33

What are non-cash operating working capital accounts and how are they handled on the statement of cash flows?

Answer 33

A current asset or liability account that derives from an operating activity and is not included in cash and cash equivalents. E.g., accounts receivable, inventory, prepaid expenses, accounts payable and accrued liabilities, unearned revenue.

• An increase in non-cash operating ASSET accounts result in decrease in cash flows from operations (CFO)
• An increase in non-cash operating LIABILITY accounts results in increase in CFO.
• E.g., if AR goes down then cash goes up because customers pay so in the statement of cash flows subtract this value. If unearned revenue increases than it must be added to net income when reconciling it with CFO.

Question 34

How to calculate the amount of dividends received to adjust for in operating activities in statement of cash flows?

Answer 34

Use a T-account for the investment

• Add opening and closing balances for the investment (debit)
• Add the investment income (debit)
• Solve for the dividend (credit)

Question 35

How to calculate the gains or losses on a sale to be included in operating activities on statement of cash flows?

Answer 35

Use a T-account for accumulated depreciation and solve for gain/loss

• Start with opening and closing balances from balance sheet (credit)
• Add the depreciation expense (credit)
• Solve for accumulated depreciation on asset sold (debit)
• Take the original cost of asset and subtract accumulated depreciation of asset sold to get the net book value
• Subtract the net book value from the amount you received for sale. If negative then a loss, if positive then a gain.

Question 36

How to calculate the amount of dividends paid to adjust for in statement of cash flows?

Answer 36

Use a T-account for retained earnings

• Add opening and closing balances (credit)
• Add net income (credit)
• Solve for dividends (debit)

Question 37

What are presentation and disclosure requirements for statement of cash flows?

Answer 37

1. Cash flows classified — operating, investing or financing
2. Cash flows operating activities — indirect or direct method
3. Major categories cash inflows and outflows are reported separately in investing and financing.
4. Cash flows interest, dividends and income taxes are individually disclosed on SCF or in notes.
5. Non-cash transactions are disclosed.
6. Components of cash and cash equivalents must be disclosed along with explanation of changes in amounts.
7. Accounting policy determining composition cash and cash equivalents must be disclosed.

Question 38

What are differences for ASPE (as compared with IFRS) with respect to statement of cash flows?

Answer 38

Under ASPE:

• Called a cash flow statement (versus statement of cash flows)
• Interest and dividend income received are classified as operating activities (versus either as operating or investing activities under IFRS)
• Dividends paid are classified as a financing activity (versus either as operating or financing activities under IFRS)
• Interest and dividends paid that are charged to R/E are financing activity (versus separate disclosure of this transaction under IFRS)
• Income taxes paid — no disclosure is required under (versus separate disclosure required under IFRS).

Question 39

What is the formula to calculate the amount of a company’s acquisition of plant and equipment for the statement of cash flows?

Answer 39

Beginning balance + acquisitions - depreciation - carrying value of assets sold = ending balance

Then rearrange for acquisitions.

Question 40

What is the formula to calculate the amount of a proceeds from the sale of plant and equipment for the statement of cash flows?

Answer 40

Book value of assets sold + gain on sale = cash proceeds from sale.

• So if asset is sold at a gain, the company received more cash than the book value of the asset sold.

Question 41

Where does interest expense get classified on statement of cash flows?

Answer 41

Operating

However, under IFRS:

• Interest paid may be classified as financing because it is a cost of obtaining financial resources
• Interest received may be classified as investing because it represents return on investment

Under ASPE it’s all operating.

Question 42

What is included in operating activities in statement of cash flows?

Answer 42

• • Net income
• Adjustments to reconcile net income to net cash provided by (used for) operating activities:
  
  • • Depreciation and amortization expense
  • • Loss on sale of investing activities
  • • Gain on sale of investing activities
  • • Increases in operating current assets (other than cash)
  • • Decreases in operating current assets (other than cash)
  • • Increases in operating current liabilities
  • • Decreases in operating current liabilities

Question 43

What is included in investing activities in statement of cash flows?

Answer 43

• • Proceeds from sales of tangible and intangible assets
• • Purchases of tangible and intangible assets
• • Sales of investments that are not cash equivalents
• • Purchases of investments that are not cash equivalents
• • Collecting on loans and advances to others
• • New loans and advances to others

Question 44

What is included in financing activities in statement of cash flows?

Answer 44

• • Proceeds from issuance of shares
• • Repurchase of shares
• • Borrowing money (loans, bonds, notes)
• • Repaying debts (loans, bonds, notes)
• • Payment of dividends

Question 45

What is the formula to calculate the carrying value of investments sold?

Answer 45

Beg. balance of long-term investments + purchase of investments - carrying value of investments sold = ending balance

Proceeds from sale = carrying value of investments sold + gain - loss

Question 46

What is the formula to determine new loans made?

Answer 46

Beginning balance + new loans made - collections = ending balance

Question 47

What is the formula to calculate repayment of long-term debt?

Answer 47

Beginning balance + borrowing of new debt - repayment of debt = ending balance

Question 48

What is the calculation for issuance of new shares?

Answer 48

Beginning balance + issuance of new shares - repurchase of shares = ending balance

Question 49

With the direct method what should be done with expenses?

Answer 49

Always put them as negative!

Question 50

With the direct method, should depreciation and amortization be included?

Answer 50

No, it can be ignored.

Since we are not using net income, we don’t need to back out depreciation and amortization.

Question 51

How are bond discounts and premiums handled in statement of cash flows?

Answer 51

Bond discounts = add to cash

Bond premiums = deduct from cash

Question 52

With the direct method, what do you do with loss on disposal of equipment?

Answer 52

Ignore it!

It is a non-cash transaction. All non-cash transactions, if material, would need to be disclosed in the financial statements. Since there is no cash involved, these transactions are not shown on the statement.