Some cash flows relating to investing or financing activities are classified as operating activities. For example, receipts of investment income (interest and dividends) and payments of interest to lenders are classified as operating activities. Conversely, some cash flows relating to operating activities are classified as investing or financing activities. For example, the cash received from the sale of property, plant, and equipment at a gain, although reported in the income statement, is classified as an investing activity, and the effect of the related gain is not included in net cash flow from operating activities. Likewise
a gain or loss on the payment of debt is generally part of the cash outflow related to the repayment of the principal amount borrowed and, therefore, is a financing activity.
Preparing the Statement of Cash Flows
8. (L.O. 2) The information used to prepare the statement of cash flows generally comes from three major sources: (a) comparative balance sheets, (b) the current income statement, and (c) selected transaction data. Actual preparation of the statement of cash flows involves three steps:
a. Determine the change in cash. The difference between the beginning and ending cash balance can be easily computed from an examination of the comparative balance sheets.
b. Determine the net cash flow from operating activities. This procedure involves analyzing not only the current year’s income statement, but also comparative balance sheets, as well as selected transaction data.
c. Determine the net cash flows from investing and financing activities. All other changes in the balance sheet accounts must be analyzed to determine their effect
9. To compute net cash flows from operating activities. It is necessary to report revenues and expenses on a cash basis. This is done by eliminating the effects of income statement transactions that did not result in a corresponding increase or decrease in cash. The conversion of accrual-based net income to net cash flow from operating activities may be done through either the direct method or the indirect method.
10. While the FASB encourages the use of the direct method when preparing the statement of cash flows, use of the indirect method is also permitted. However, if the direct method is used the FASB requires that a reconciliation of net income to net cash flow from operating activities shall be provided in a separate schedule. Therefore, under either method, the indirect (reconciliation) approach must be presented. The text book includes comprehensive illustrations which provide a detailed explanation of the preparation and presentation of the statement of cash flows.
11. When non-cash current asset accounts increase and non-cash current liability accounts decrease, the change is subtracted from net income.
When non-cash current asset accounts decrease, and non-cash current liability accounts increase, the change is subtracted from net income.
Non-cash items such as depreciation, amortization, and losses are added to net income, while gains are subtracted.
12. The schedule shown below presents the common types of adjustments that are made to net income to arrive at net cash flow provided by operating activities under the indirect method.
Additions to Net Income
Amortization of intangibles and deferred charges.
Amortization of bond discount.
Increase in deferred income tax liability.
Loss on investment in common stock using equity method.
Loss on sale of plant assets.
Loss on impairment of assets.
Decrease in receivables.
Decrease in inventories.
Decrease in prepaid expenses.
Increase in accounts payable.
Increase in accrued liabilities.
Deductions from Net Income
Amortization of bond premium.
Decrease in deferred income tax liability.
Income on investment in common stock using equity method.
Gain on sale of plant assets.
Increase in receivables.
Increase in inventories.
Increase in prepaid expenses.
Decrease in accounts payable.
Decrease in accrued liabilities.
Investing and Financing Activities
13. Investing activities include the analysis of all long-term asset accounts to determine any cash flow effects. The following are common investing cash flow effects, though non-cash effects may possibly cause the same effects in the long-term asset accounts.
a. A purchase of land will appear as an increase in the land account and will appear as an investing cash outflow.
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