Questions
The statement of cash flow serves as a bridge between the cash basis bank transactions and the accrual basis financial statements (balance sheet, income statement, and retained earnings statement). It reveals where the cash came from, and where it went.
Any transaction that is related to acquiring or disposing of long-term assets like land, buildings, equipment, stocks, bonds, or other investments. Can be cash spent for purchase of long-term assets, or cash collected from sale of long-term assets.
The indirect method begins with net income and adjusts for items that affect cash differently than they affect net income, whereas the direct method requires that each revenue and expense item be converted to reflect the cash impact from that item. The net cash flow result is the same, no matter which of the two methods is used.
Gains and losses must be removed from the operating section. To accomplish this, reverse the effect of gains or losses; if a gain has been added to net income, it should be subtracted in the operating section; if a loss has been deducted to arrive at net income, it should be added back in the operating section. Why? First, gains and losses relate to long-term assets, which fall under investing activities, not operating activities. Second, the gain/(loss) on the sale of long-term assets represents the excess/(deficiency) computed when the asset’s cost basis is subtracted from sales proceeds, so the number does not accurately represent the cash flow relating to the transaction.
Not necessarily. Only the principal balance repayment should be included in the financing section; the interest component of the note payment is an operating activity.
Yes. Some investing and/or financing transactions do not have a cash impact initially. Examples include purchases of long-term assets that are paid for with long-term debt financing, acquisitions of long-term assets in exchange for corporate stock, and repayment of long-term debt using noncash assets. These noncash investing/financing activities would be reported in the notes to the financial statements, or as a notation on the bottom of the statement of cash flows, but not considered an integral part of the statement.
Using the direct method to prepare the operating section requires that revenue and expense items be converted to the cash basis of accounting, since these items are recorded in company records using the accrual basis of accounting. The balance sheet, income statement, and retained earnings statement use the accrual basis balances that are maintained in the company accounting records, and thus can be obtained directly from the adjusted trial balance, without modifications.