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FA2 Module 3. Cash Flow Statement - University of Manitoba

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FA2Module 3.Statement of Cash Flow
Definition and objectivesClassification of elementsDirect and indirect methodsGains and lossesThe T-account methodAccounts receivable
1.SCF:Definition and objectives
TheStatement of CashFlow(formerly Statement of Changes in Financial Position) shows the changes inCash and Cash Equivalentsarising 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; and3. assessing the firm=s ability to generate cash from internal sources.
Cash and cash equivalents
Cash and cash equivalentsinclude cash, plus temporary investments that are highly liquid (e. g., maturities of three months orless, like treasury bills).Investments in equities areexcluded(no maturity date).Bank overdraftcan be considered “negative” cashequivalent if bank balance fluctuates regularly between positive and negative.
Classification of elementsa. Operating activities
Classification of elementsb. Investing activities
Classification of elementsc. Financing activities
Classification ofelements -Choices
Format of theSCF
Operating activitiesNet cash flows from operations $Investing activitiesAcquisitions of non-current assets ($)Dispositions of non-current assets$Net cash from (used by) investing activities $Financing activitiesIssues of shares/debt $Redemption ofshares/debtrepayment($)Net cash from (used by) financing activities$Net change in cash and cash equivalents $
3.SCF:Direct and indirect methods
There are two methods of presentation of theSCF:the direct and indirect methods. The only difference is in the presentation of cash from operating activities.Direct method(preferredbyIFRS)Cash inflows from operations $Cash outflows related to operations$Net cash from operations $Indirect methodNet income $+/- diff. between accrual and cashacctg$Net cash from operations$
Direct method
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.):
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:A5-13
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 thestatement of cash flow;the gain or loss should not.
Gains, losses and the cash flow statement
Direct methodGains and losses are generally not included in operating activities; the related cash flow is presented in the appropriateSCFsection.Indirect methodGains are deducted from, and losses added back to, net income in the operating activities section. The related cash flow is presented in the appropriateSCFsection.
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.
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 methodSCF.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.
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.
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:A5-22
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 expenseSome accounts receivable are never collected (write-offs)
Accounts receivable transactions
Dr. Accounts receivable SalesCr. RevenueDr. Cash CollectionsCr. Accounts receivableDr. Bad debt expense Est. bad debtsCr. Allowance for doubtful accountsDr. Allowance for doubtful accounts write-offsCr. Accounts receivable
Gross accounts receivable method
SCF example: Gould Inc.
Net accounts receivable method
Net cash from operating activities(Credit sales, cash expenses except bad debt)

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FA2 Module 3. Cash Flow Statement - University of Manitoba