FA2 Module 3' Cash Flow Statement

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FA2Module 3. Cash Flow Statement

• Definition and objectives
• Classification of elements
• Direct and indirect methods
• Gains and losses
• The T-account method
• Accounts receivable

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Online solutions to textbook problems

• Go to Beechy textbook website
• http//www.mcgrawhill.ca/college/beechy/
• Click on 3rd edition textbook
• On the next screen, click on Student Edition (on
  the left-hand side of the screen)
• Click on the Choose one. . . box to select a
  particular chapter
• Under More Resources, click on Student Solutions

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1. CFS Definition and objectives

• The Cash Flow Statement (formerly Statement of
  Changes in Financial Position) shows the changes
  in Cash and Cash Equivalents arising from the
  operating, financing and investing activities of
  the enterprise. This information is useful for
• 1. understanding effects of operating, financing
  and investing activities on cash
• 2. assessing liquidity and solvency and
• 3. assessing the firms ability to generate cash
  from internal sources.

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Cash and cash equivalents

• Cash and cash equivalents include cash, plus
  temporary investments that are highly liquid (e.
  g., maturities of three months or less)
• money market accounts
• treasury bills
• Marketable Securities are often excluded.
• Liquid liabilities (e. g., line of credit) can be
  considered negative cash equivalents.

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Classification of elementsa. Operating
activities
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Classification of elementsb. Investing
activities
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Classification of elementsc. Financing
activities
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Format of the CFS

• Operating activities
• Net cash flows from operations
• Investing activities
• Acquisitions of non-current assets ()
• Dispositions of non-current assets
• Net cash from (used by) investing activities
• Financing activities
• Issues of shares/debt
• Redemption of share/debt repayment ()
• Net cash from (used by) financing activities
• Net change in cash and cash equivalents

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3. CFS Direct and indirect methods

• There are two methods of presentation of the CFS
  the direct and indirect methods. The only
  difference is in the presentation of cash from
  operating activities.
• Direct method (now preferred by the CICA)
• Cash inflows from operations
• Cash outflows related to operations
• Net cash from operations
• Indirect method
• Net income
• /- diff. between accrual and cash acctg
• Net cash from operations

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Direct method
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Indirect method

• Starting point is net income.
• Eliminate revenues and expenses that do not
  provide or use cash (e. g., amortization).
• The resulting figure is adjusted for changes in
  balance sheet accounts that are associated with
  operating activities (e. g., accounts receivable,
  inventory, accounts payable, etc.)

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Indirect method (two-step presentation)

• Net income
• - Non-cash revenues ()
• Non-cash expenses
• Changes in non-cash working capital
• - increases in associated assets ()
• decreases in associated assets
• increases in associated liabilities
• - decreases in associated liabilities ()
• Net cash from operations
• Example A5-29

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4. Gains and losses

• Gains and losses arise from incidental and/or
  peripheral transactions that tend to be investing
  (e. g., sale of fixed asset) or financing (e. g.,
  retirement of debt) activities. The gain or loss
  is generally the difference between any net cash
  flow related to the transaction and the book
  value of the asset or liability in question. The
  cash flow should be in the cash flow statement
  the gain or loss should not.

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Gains, losses and the cash flow statement

• Direct method
• Gains and losses are generally not included in
  operating activities the related cash flow is
  presented in the appropriate CFS section.
• Indirect method
• Gains are deducted from, and losses added back
  to, net income in the operating activities
  section. The related cash flow is presented in
  the appropriate CFS section.

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Gain example Hogan Ltd

• Sales for the year were 70. Operating expenses
  for the year were 40. Aside from depreciation
  (5), there were no non-cash sales or expenses.
  During the year, Hogan sold a piece of equipment
  (cost 22 accumulated depreciation 7) for
  25. There were no other investing or financing
  activities during the year. The tax rate is 20
  and all taxes were paid during the year.
• Required Prepare the income statement.
• Prepare the cash flow statement using (1) the
  direct method and (2) the indirect method.

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5. The T-account method

• The T-account method is a quick, informal way to
  organize information to prepare a cash flow
  statement. It works best for indirect method
  CFS. The steps are
• Prepare t-accounts for each balance sheet account
  with the beginning and ending balance. There are
  3 cash and cash-equivalent accounts, one for each
  of the cash flow statement sections.

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5. The T-account method

• Go through the income statement and additional
  information and post the implied transactions
  to the t-accounts. Non-cash income statement
  items are posted to Cash from operating
  activities.
• Go through each of the balance sheet accounts and
  identify any unexplained variations. Using the
  most obvious explanation, assume and post the
  transaction.

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5. The T-account method

• Using the numbers in the three cash accounts,
  assemble the cash flow statement.
• Often-used shortcut Do not bother with
  t-accounts for the working capital accounts
  usually, only the changes in these accounts
  matter. The non-working capital accounts are
  frequently affected by more than one cash
  transaction.
• Example Secada

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6. Accounts receivable

• The usual cash flow statement treatment accorded
  accounts receivable and cash collections from
  customers is to add (subtract) the decrease
  (increase) in accounts receivable. The situation
  is usually more complicated than that because
• Bad debt expense is a non-cash expense
• Some accounts receivable are never collected
  (write-offs)

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Accounts receivable transactions

• Dr. Accounts receivable Sales
• Cr. Revenue
• Dr. Cash Collections
• Cr. Accounts receivable
• Dr. Bad debt expense Est. bad debts
• Cr. Allowance for doubtful accounts
• Dr. Allowance for doubtful accounts write-offs
• Cr. Accounts receivable

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Gross accounts receivable method
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Net accounts receivable method
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Net cash from operating activities(Credit sales,
cash expenses except bad debt)