1) With respect to a balance sheet with categories Assets, Liabilities, and Equity, construct a simple...

1) With respect to a balance sheet with categories Assets, Liabilities, and Equity, construct a simple mathematical equation that links the three. How is the Income Statement different from the Statement of Cash Flows? How does accrual accounting partially explain this? Which one is the most important to discerning the company’s true operating story and then forecasting its future prospects?

Expert Solution

The mathematical equation with assets, liabilities and equity in balance sheet is: Assets = Liabilities + Equity.

Income statement is different from the statement of cash flows in the following aspects:

1) Income statement is prepared in accrual basis while statement of cash flows is prepared in cash basis.

2) Income statement provides information about profitability while cash flow statement provides information liquidity.

Accrual accounting refers to the inclusion of the income and expenses of a firm over a certain time period. This is taken into consideration in Income statement. But in cash flow statement, cash basis of accounting is considered as the actual cash inflows and outflows are only considered.

I believe that the income statement is more important to understand the company's true operating story and forecasting future prospects as it includes the details about the assets as well as the liabilities. The cash flow statement is about only cash inflows and outflows. It does not give a a holistic picture about the company.

jeff jeffy answered 2 years ago

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