Question

In: Accounting

In this discussion question, you will describe the preparation of the statement of cash flows. How...

In this discussion question, you will describe the preparation of the statement of cash flows.

How does the preparation of the statement of cash flows differ between the direct method and the indirect method? How is the preparation similar between the two methods? Where should you start when preparing the statement of cash flows? Is the starting point different between the direct method versus the indirect method? What documents will you need to prepare the statements? How will you know if you prepared the statement correctly?

Solutions

Expert Solution

The 5 financial statements prepared by business entities under US GAAP ( Generally Accepted Acounting Principles) are as follows :

1)Statement of financial position(Balance sheet)

2)Income statement

3) STATEMENT OF CASH FLOWS

4) Statement of comprehensive income

5)Statement of changes in stockholders' equity

CASH FLOW STATEMENT : On the statement of cash flow, 'CASH' means total of cash, cash equivalents, restricted cash and restricted cash equivalents. Here, cash equivalents means those items which can be easily convertable into cash(high liquidity). For eg; BANK, MARKETABLE SECURITIES(those securities which can be realise within 3 months). Restricted cash means those cash which is saved for the use of a particular thing. For eg; $100000 is kept only for paying some particular loans.

The main aim of preparing cash flow is to provide information of receipts and usage of cash.

Cash flow statement can be prepared by 2 methods:

1) DIRECT METHOD( TOP TO BOTTOM APPROACH)

2) INDIRECT METHOD ( BOTTOM TO TOP APPROACH)

The main difference between both method is that only the CALCULATION OF OPERATING ACTIVITY IS DIFFERENT. Calculation of investing and financing activity are same in both methods. Operating activity includes core/main activity of the business.

FORMAT OF DIRECT METHOD OF CALCULATING OPERATING ACTIVITY

PARTICULARS

AMOUNT

CASH SALES

(+) COLLECTION FOM DEBTORS

(-)   CASH PURCHASES

(-) PAYMENT TO CREDITORS

(-) OPERATING EXPENSES ( salary, office expenses etc)

(-) TAX PAID

CASH FLOW FROM OPERATING ACTIVITY

XXXXXXXX

XXXXX

(XXX)

(XX)

(xx)

(XX)

XXXXXX

FORMAT OF INDIRECT METHOD FOR CALCULATING OPERATING CASH FLOW

PARTICULARS

AMOUNT

NET PROFIT

(+) NON CASH EXPENSES (depreciation etc)

(+) NON OPERATING EXPENSES (loss by fire, loss on sale of fixed asset)

(-)NON CASH INCOME (unrealised income)

(-) NON OPERATING INCOME( profit on sale of fixed asset etc)

(-) INCREASE IN CURRENT ASSET

(-) DECREASE IN CURRENT LIABILITY

(+) INCREASE IN CURRENT LIABILITY

(+) DECREASE IN CURRENT ASSET

(-) TAX PAID

                                                                

CASH FLOW FROM OPERATING ACTIVITY

XXXXXXX

xxxx

XXXX

(XXXX)

(XXX)

(xx)

(XX)

XX

XX

(xx)

XXXXXXX

In both method , investing activity includes purchase of PPE (PLANT,PROPERTY AND EQUIPMENT), Purchase of investments, Sale of PPE, Loan given, Loan given etc.

Financing activity includes, Loan taken, Loan repayment, Dividend paid, Issue of shares, Redemption of shares etc.

NOTE ; Dividend received, interest received and interest paid includes in OPERATING ACTIVITY ACCORDING TO GAAP. Indirect method is commonly used method.

CASH FLOW STATEMENT IS PREPARED WHEN THE SUM TOTAL OF INFLOW AND OUTFLOW OF OPERATING, INVESTING AND FINANCING ACTIVITY and ADD opening cash balance. The final answer we get is CLOSING BALANCE OF CASH FLOW. For preparing cash flow , we need statement of financial position and income statement items. We can check the statement is correctly prepared or not by checking the change in cash in balancesheet.

PARTICULARS

AMOUNT

CASH FLOW FROM OPERATING ACTIVITY:

NET PROFIT

(+) NON CASH EXPENSES (depreciation etc)

(+) NON OPERATING EXPENSES (loss by fire, loss on sale of fixed asset)

(-)NON CASH INCOME (unrealised income)

(-) NON OPERATING INCOME( profit on sale of fixed asset etc)

(-) INCREASE IN CURRENT ASSET

(-) DECREASE IN CURRENT LIABILITY

(+) INCREASE IN CURRENT LIABILITY

(+) DECREASE IN CURRENT ASSET

(-) TAX PAID

                                                                

CASH FLOW FROM OPERATING ACTIVITY

CASH FLOW FROM INVESTING ACTIVITY :

Sale of PPE

(-)Purchase of PPE

NET CASH FLOW FROM INVESTING ACTIVITY

CASH FLOW FROM FINANCING ACTIVITY:

Issue of shares

(-) Dividend paid

NET CASH FLOW FROM FINANCING ACTVITY

Net increase in cash, cash equivalents(operating+investing+financing)

(+) opening cash balance

CASH,CASH EQUIVALENTS & RESTRICTED CASH AT END

XXXXXXX

xxxx

XXXX

(XXXX)

(XXX)

(xx)

(XX)

XX

XX

(xx)

XXXXXX

XXXXXX

(XX)

XXXXXX

Xxxxx

(Xxx)

Xxxxx

XXXXXX

Xxxx

xxxxxxxx


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