Unit 10 Study Guide: Cash Flow Preparation and Use

10a: Define the purpose of the statement of cash flows.

The Financial Accounting Standards Board created the statement of cash flows in 1987 to accompany three main financial statements, the income statement, balance sheet, and statement of owners’ equity.

    • Why did the Financial Accounting Standards Board create a standard form businesses could use for the statement of cash flows?
    • Why should companies report their changes in cash, from the beginning to the end of the period, when using accrual basis accounting.

Review Purpose of the Statement of Cash Flows from Managerial Accounting.

10b: Describe the three categories of cash flows.

The statement of cash flows reports cash inflows and outflows for three different categories.

    • Name the three categories included in a statement of cash flows.
    • List the types of activities included in each category of the statement of cash flows.
    • Identify the category generally considered to be the most relevant.

Review Three Types of Cash Flow Activities from Managerial Accounting.

10c: Describe the four steps used to prepare the statement of cash flows.

There are four steps involved in preparing a statement of cash flows with the indirect method.

Step 1: Prepare the operating activities section by converting net income from the accrual basis to the cash basis of accounting.
Step 2: Prepare the investing activities section by presenting cash inflows and cash outflows for non-current assets.
Step 3: Prepare the financing activities section by presenting cash inflows and cash outflows for non-current liabilities and owner's equity.
Step 4: Reconcile the change in cash from the beginning of the period to the end of the period.
 
    • Define non-current assets.
    • Define accrual basis accounting.
    • Define cash basis accounting.
    • Where can managers find the information they need to prepare a statement of cash flows?

Review Four Key Steps to Preparing the Statement of Cash Flows from Managerial Accounting.

10d: Prepare a statement of cash flows using the indirect method.

To create a statement of cash flows with the indirect method:

1. First, prepare the operating activities section.

    • How do managers begin compiling the operating activities section?
    • How do managers make the first adjustment: adding non-cash expenses (depreciation and/or amortization) to net income?
    • How do managers make the second adjustment: adding back losses to net income and deducting gains from net income?
    • How do managers make the third adjustment: adding and subtracting changes in current assets during the period?
    • How do managers apply the current asset rule: treating increases and decreases in current assets during the third adjustment?

2. Next prepare the investing activities section.

    • How do managers treat cash outflows for investments in non-current assets?
    • How do managers treat cash inflows and a corresponding gain or loss on the disposal of non-current assets?
    • Describe the effect of accumulated depreciation in calculating gains or losses on the disposal of non-current assets.

3. Next prepare the financing activities section.

    • Identify the changes in non-current liabilities and owner's equity in the section of the balance sheet.
    • Report cash inflows that result from the issue of debt or equity securities. Don’t forget to consider the change in paid-in capital in excess of par.
    • Report cash outflows that result from the retirement of debt securities or the purchase of treasury stock.

4. Finally, reconcile the change in beginning cash to the ending cash balance.

    • How do managers report the reconciliation of cash on the statement of cash flows?
    • Describe the reporting requirements for non-cash activities that cause changes in balance sheet accounts.

Review Four Key Steps to Preparing the Statement of Cash Flows from Managerial Accounting.

Review these six examples of statement of cash flows:

Figure 12.3 Balance Sheet and Income Statement for Home Store, Inc.

Figure 12.3 Balance Sheet and Income Statement for Home Store, Inc.

Figure 12.4 Operating Activities Format and Adjustments

Figure 12.4 Operating Activities Format and Adjustments

Figure 12.5 Operating Activities Section of Statement of Cash Flows (Home Store, Inc.)

Figure 12.5 Operating Activities Section of Statement of Cash Flows (Home Store, Inc.)

Figure 12.6 Investing Activities Section of Statement of Cash Flows (Home Store, Inc.)

Figure 12.6 Investing Activities Section of Statement of Cash Flows (Home Store, Inc.)

Figure 12.7 Financing Activities Section of Statement of Cash Flows (Home Store, Inc.)

Figure 12.7 Financing Activities Section of Statement of Cash Flows (Home Store, Inc.)

Figure 12.8 Statement of Cash Flows (Home Store, Inc.)

Figure 12.8 Statement of Cash Flows (Home Store, Inc.)

10e: Analyze cash flow information.

Companies use three important ratios to analyze the statement of cash flows.

    • Define and describe the importance of the operating cash flow ratio.
    • Define and describe the importance of the capital expenditure ratio.
    • Define and describe the importance of free cash flows.

Review Analyzing Cash Flow Information from Managerial Accounting.

10f: Prepare a statement of cash flows using the direct method.

The direct method offers an alternative to the indirect method of preparing a statement of cash flows. The only difference between these two methods lies in how managers prepare the operating activities section. Managers report the investing and financing sections in the same way for both methods. The direct method is rarely used.

    • How do managers convert income statement accounts from using an accrual basis of reporting to cash basis of reporting?

Review Appendix: Using the Direct Method to Prepare the Statement of Cash Flows from Managerial Accounting.

Unit 10 Vocabulary

      • Accumulated depreciation
      • Balance sheet
      • Capital expenditure ratio
      • Current assets
      • Current liabilities
      • Direct method
      • Financing activities
      • Free cash flow
      • Income statement
      • Indirect method
      • Investing activities
      • Operating activities
      • Operating cash flow ratio
      • Statement of cash flows
Last modified: Wednesday, July 17, 2019, 5:45 PM