23 CHAPTER Cash Flow Statement A. Purposes and Uses of Statement of Cash Flows. 1. Purposes of the statement. a. To provide information about the cash receipts and cash payments of an entity during a period. Important information for financial statement users because many feel that accrual accounting does not present true picture. b. To summarize the operating, investing, and financing activities of the business. 2. Uses of the statement. a. Assessing the entity's ability to generate positive future cash flows. b. Assessing the entity's ability to pay dividends and meet obligations. c. Reconciling the difference between net income and net cash flow from operating activities. d. Assessing the cash and noncash investing and financing transactions during the period. B. Classification of Cash Flows and Format of Statement of Cash Flows. 1. Operating activities: transactions related to the calculation of net income. 2. Investing activities: transactions related to long-term assets. 3. Financing activities: transactions related to liabilities and stockholders' equity. 4. Format of the statement. C. Preparation of the Statement of Cash Flows. 1. Sources of information. a. Comparative balance sheets. b. Current income statement. c. Selected transaction data. 2. Steps. a. Determine the change in cash and cash equivalents. b. Determine the net cash flow from operating activities. c. Determine cash flows from investing and financing activities. D. Indirect Method to Determining Net Cash Flow from Operating Activities. 1. Start with net income and make adjustments for items which affect net income but do not affect cash. 2. Make adjustments for changes in working capital accounts that affect income. 3. Make adjustments for gains and losses.
E. Direct Method. 1. Schedule of changes from accrual to cash basis income statement. 2. Cash flows from operating activities. 3. Direct method must also provide a separate schedule showing the reconciliation of net income to net cash provided by operating activities. F. Direct vs. Indirect Controversy 1. Direct method has the advantage of showing operating cash receipts and payments. 2. Indirect method has the advantage of reconciling net income with net cash flow from operating activities. 3. Although the FASB prefers the direct method, it permits the use the of indirect method. 4. Users of the direct method are required, at a minimum, to report separately: a. Cash receipts (1) Cash collected from customers. (2) Interest and dividends received. (3) Other operating cash receipts, if any. b. Cash payments (1) Cash paid to employees and suppliers of goods or services. (2) Interest paid. (3) Income taxes paid. (4) Other operating cash payments, if any. 5. Indirect method users are required to disclose separately: (1) Changes in inventory, receivables, and payables to reconcile net income to net cash flow from operating activities. (2) Interest paid. (3) Income taxes paid. G. Special Problems in Preparing a Statement of Cash Flows. 1. Adjustments similar to depreciation. Amortization of intangible assets, deferred costs, bond discount or premium, and changes in deferred income taxes. a. Also changes related to an investment accounted for under the equity method. 2. Accounts receivable. a. Indirect method. Increase/decrease in the Allowance for Doubtful Accounts should be added/deducted from net income or, just compare the change in accounts receivable on a net basis. b. Direct method. Do not net the accounts receivable. If accounts have been written off an additional adjustment is necessary. 3. Other working capital changes. a. Items that affect cash, but not net income: (1) Purchase of short-term available-for-sale securities. ...