Question

Question: CA23-5 (Purpose and Elements of SCF) GAAP requires the statement of cash flows be presented when financial statements are prepared.

Instructions

(a) Explain the purposes of the statement of cash flows.

(b) List and describe the three categories of activities that must be reported in the statement of cash flows.

(c) Identify and describe the two methods that are allowed for reporting cash flows from operations.

(d) Describe the financial statement presentation of noncash investing and financing transactions. Include in your description an example of a noncash investing and financing transaction.

Short answer

Answer

1. Cash flow statement is prepared to provideinformation to the investors and the creditors.
2. Cash flow statement has three sections: investing,operating, andfinancing.
3. There aretwo methods to prepare a cash flow statement: direct and indirect.
4. Non-cash investing and financing transactions are reported by preparing a separate schedule at the bottom of the cash flow statement.

Step-by-step solution

Definition of Statement of Cash Flow

The schedule prepared by the business entity for providing a summary of all the transactions, including cash payments and receipts, is known as the statement of cash flow.

Purpose of the statement of cash flows

The cash flow statement is prepared for:

1. Determining the ability of the business entity to generate cash.
2. Determining the potential of the business entity to pay dividends and meet other cash obligations.
3. To determine the reason behind the difference between the cash flow from operating and net income.
4. To identify the cash and non-cash transactions related to investing and financing transactions.

Categories of activities reported in the statement of cash flows

Operating activities: This section of the cash flow statement reports the cash effect of all the transactions that are reported for the calculation of the net income of the business entity.

Investing activities: This section reports the transactions related to the long-term assets of the business entity affecting the cash position.

Financing activities: This section reports the transaction relating to the equity and liability affecting the cash position of the business entity.

Methods for reporting cash flow

Direct Method: Under the direct method, the business entity calculates the net cash flow from operation by taking the difference between the operating cash receipts and operating cash disbursement.

Indirect Method: Under the indirect method, the business entity calculates the net cash flow from operating activities by adjusting the net income with the transactions that will affect net income without affecting the cash position. After adjusting net income, the business entity adds and deducts the investing and financing transactions affecting the cash position. After this, the investing and financing transaction affecting the cash position is reported.

Presentation of non-cash investing and financing transaction

The business entity's non-cash investing and financing activities are reported in a separate schedule prepared at the bottom of the cash flow statement.

Example of transactions:

1. Investing transaction: Acquisition of any fixed asset by issuing securities.
2. Financing transaction: Conversion of debt securities into equity.