Question

Bart Sampson, the owner-president of Computer Services International, is unfamiliar with the statement of cash flows that you, as his accountant, prepared. He asks for further explanation.

 

Instructions

Write him a brief memo explaining the form and content of the statement of cash flows as shown in Illustration 17.14.

Answer 1

The accountant should explain to Will Harden the below mentioned purpose or objective behind preparation of Cash Flow Statement:

 

1. Statement of cash flows indicates the liquidity and solvency position of the firm. This information is depicted in detail by recording the various transactions in the statement.

 

2. It reveals the sources and uses of cash flows which otherwise are not obvious from the financial statements namely income statement and balance sheet e.g changes in each type of current assets, namely increase or decrease in current assets is readily apparent once cash flow statement is prepared.

 

3. Income statement and balance sheet are prepared as per accrual basis of accounting wherein non-cash revenue and expense items are included. Thus, it leads to differences between the amount of income as per the income statement and the net change in cash flows which are reflected from the cash flow statement. Thus, the accurate cash position is reflected only through a cash flow statement.

 

4. Cash flow statement shows the inflows and outflows of cash from different activities which are classified as operating, financing and investing. This information shows the ability of the firm to generate funds and their usage. Thus, this information is necessary from the investor’s point of view.

 

5. The cash flow statement also explains the major reasons behind the changes in the opening and closing balance sheet’s cash and cash equivalents. The reasons are evident from the net changes in the operating, financing and investing activities.

 

6. Statement of cash flows is also important from analysis point of view. Mere preparation of the financial statements is not sufficient unless the information included therein is understood properly. Thus, a cash flow statement serves as a tool for analysis of the financial statements and gives a clear picture of the operations of the firm.

 

7. Since activities are classified into three categories, it shows the amount of money involved in non-core activities namely investing and financing. This is important because such activities are even though non-core; play a significant role by affecting the current and future cash flows of the firm.

 

8. The statement of cash flows is prepared as per the accounting standards. Thus, from the legal and regulatory angle, it is imperative for firms to report their cash flows by preparing a cash flow statement.

9. Preparing a cash flow statement periodically helps to compare them on an annual basis. This will help to detect any fraud in its initial stages itself. Thus, diagnosis at the right time can prevent any catastrophic events arising in future.

 

(II)

Explanation for the three adjustments is as follows:

1. Depreciation expense of $9000 is added back to the net income while preparing the statement of cash flows because it is a non-cash expense which was deducted in the income statement to find out the net income. Since, no cash was involved in this expenditure, it is added back to find out the net cash flow from operating activities.

 

2. Purchase of building $120000 is deducted in order to find out the net cash flow from investing activities because purchase of an asset is an investment which will yield benefits in future and also involves disbursement of cash which denotes outflow of cash from the firm.

 

3. Payment of cash dividends $29000 is deducted in order to find out the net cash flow from financing activities because dividend is paid to the stockholders for the investment made in the firm. Investment by stockholders is a financing activity resultant which payment of dividend also falls in the same category. Besides, payment of dividend involves outflow of cash.

The accountant should explain to Will Harden the below mentioned purpose or objective behind preparation of Cash Flow Statement: