Intermediate Accounting
Thomas H. Beechy
Schulich School of
Business,
York University
Joan E. D. Conrod
Faculty of Management
Dalhousie University
Powerpoint slides by:
Michael L. Hockenstein  Commerce Department • Vanier College
Copyright © 2003 McGraw-Hill Ryerson Limited, Canada
Cash Flow Statement
Chapter 5
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Introduction
 The cash flow statement
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 reveals the operating cash flow of the company
 enables the user to reconcile the cash flows
to net income
The cash flows of an enterprise are of prime
importance to many users of the financial
statements
The AcSB has identified cash flow prediction
as a principal objective of financial reporting
The starting point of cash flow prediction is
the analysis of historical cash flows
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Evolution of the Cash Flow Statement
 The cash flow statement has evolved over the past
twenty years
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The title of cash flow statement is fairly recent
In 1985, the AcSB substantially revised Section 1540
to eliminate the working capital approach and focus
instead on cash flows
Previous historical analysis of long-term assets, longterm liabilities, and owners’ equities shifted to that of
analyzing cash flows, regardless of the nature of the
flows
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Cash Flow Reporting
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Cash versus accrual
Definition of cash
Classification of cash flows
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Cash vs. Accrual
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Under the accrual basis, financial assets and
liabilities (that is, receivables and payables) are
recorded when the reporting enterprise has a right to
receive cash or the obligation to pay cash, rather than
later when the cash flows actually occur
On the cash flow statement, the effects of both
accruals and interperiod allocations (such as
depreciation and amortization) are eliminated, leaving
only the cash flows
Cash flow is not affected by accounting policy choice
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Cash vs. Accrual (cont.)
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Receipts and disbursements are cash inflows and
outflows
They can be for any purpose, whether to generate
operating earnings, change the asset structure, or
increase or decrease liabilities
Because of the accrual concept, a cash receipt or
disbursement that gives rise to a revenue or expense
may occur in a different period than that in which the
revenue or expense is recognized
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Definition of Cash
 For purposes of the cash flow
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statement, “cash” includes:
 cash on hand
 cash on deposit
 cash equivalents---highly liquid short-term
investments
Investments in shares are explicitly excluded
In Canada, corporations often maintain lines of credit
with their banks that may be used as a cash account
to run a negative balance, or overdraft
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Definition of Cash (cont.)
“for an investment to qualify as a cash equivalent it
must be readily convertible to a known amount of
cash and be subject to an insignificant risk of
changes in value” [CICA 1540.08]. “3 months
maximum maturity period”
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Classification of Cash Flows
 Operating activities: the principal revenue
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producing activities of the enterprise and the
related expenditures
The cash inflow from operations is measured as the
cash received from customers or clients, plus activities
such as finance revenue
The cash outflows are those disbursements that are
incurred to earn the inflow, such as cash paid for
inventories, wages and salaries, and overhead costs
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Classification of Cash Flows (cont.)
 Investing activities: those activities that relate to
the asset structure of the company, including the
acquisition and disposal of tangible and intangible
capital assets and investments in other assets that are
not included in cash equivalents
 Financing activities: those that relate to the
liabilities and owners’ equity. Cash flows that increase
or decrease the size or composition of the accounts on
the right side of the balance sheet are reported in this
section
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Exhibit 5-1
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Exhibit 5-1 (cont.)
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Exhibit 5-1 (cont.)
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Exhibit 5-2
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Exhibit 5-2 (cont.)
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Preparing The Cash Flow Statement
 Basic Approach to Preparation
 Analyzing Cash Flow
 Presentation of Operations
 Offsetting Transactions
 Non-Cash Transactions
 Cash Flow per Share
 Quality of Earnings
 Effect of Accounting Policy Choices
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on the Cash Flow Statement
Summary of Disclosure Recommendations
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Basic Approach to Preparation
 The Balance Sheet, Income Statement, and
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Retained Earnings Statement are all prepared
from the trial balance manually or, by
computerized systems
The classification of the balance of each
account is unambiguously pre-specified in the
programming, and the statements (other than
the cash flow statement) emerge more or less
automatically from the system
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Basic Approach to Preparation (cont.)
 The cash flow statement is prepared by

analyzing account balances and changes in
balances
Standard computerized accounting systems
normally cannot do that, therefore the cash
flow statement is usually a hand-prepared
statement
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Exhibit 5-4
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Presentation of Operations
 Direct presentation: revenues and expenses are
adjusted to a cash basis of reporting and shown
directly in deriving cash provided by (or used by)
operations on the cash flow section (Exhibit 5-5)
 Indirect presentation: Operations begin with net
income, and all interperiod allocations and accruals
are reversed out of net income to derive the cash from
operations (Exhibit 5-4)
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Exhibit 5-5
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Offsetting Transactions
 In the investing and financing sections, gross
cash flows (gross cash receipts and gross
cash payments) are reported separately
 Transactions relating to similar items of
asset or equity structure should not be
netted
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Non-Cash Transactions
 Common types of non-cash transactions
include:
 retiring bonds through share issuance
 converting bonds to shares
 converting preferred shares to common
shares
 settling debt by transferring non-cash
assets
 bond refinancing
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Non-Cash Transactions (Cont.)
 incurring capital lease obligations in
exchange for leased assets
 acquiring shares in another company in
exchange for shares of the reporting enterprise
 distributing assets other than cash as dividends
(e.g., a spin-off of a subsidiary company)
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Cash Flow Per Share
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Financial analysts and other users often compute
cash flow per share, which is defined in many
different ways
One common measure of cash flow per share is net
operating cash flow divided by common shares
outstanding
The CICA Handbook is silent on the issue,
which allows Canadian companies to use
their judgement in this area.
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Quality of Earnings
 Earnings quality: relates the amount of net income
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to the amount of cash flow from operations
A company is said to have high quality earnings
when there is a close correspondence between net
income and cash flow from operations, especially if the
close relationship between earnings and cash flow
persists over several years and move in the same
direction
A company that reports earnings that are not closely
related to cash flows is said to have low quality
earnings
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Effect of Accounting Policy Choices on the
Cash Flow Statement
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One of the reasons that users like to see the cash flow
statement is that “cash doesn’t lie”
Accounting policy decisions and management’s measurement
estimates can significantly affect net income, but they will have
no impact on the underlying cash flow
The decision whether to capitalize or expense an expenditure
does affect the cash flow statement
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Summary of Disclosure Recommendations
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The CICA Handbook recommends the following
disclosures:
 statement should report the changes in cash and
cash equivalents, net of bank overdrafts, resulting
from the activities of the enterprise during the
period
 the components of cash, cash overdrafts, and
cash equivalents should be disclosed and should
be reconciled with the balance sheet.
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Summary of Disclosure Recommendations (cont.)
 the statement should include only cash flows;
non-cash transactions should not be reported
on the cash flow statement, but should be
disclosed elsewhere in the financial statements
as appropriate
 cash flows during the period should be classified
by operating, investing, and financing activities
 reporting enterprises are encouraged to report
cash flows from operations by the direct method
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Summary of Disclosure Recommendations (cont.)
 cash flows from investing and financing activities
should not be netted or offset; the gross amount of
inflows and outflows should be reported
 cash flows relating to extraordinary items should be
classified according to their nature as operating,
investing, or financing activities, and should be
separately disclosed
 the gross amounts of cash flows from interest and
dividends (both received and paid) should be
disclosed separately; interest and dividends that
have been included in net income should be
separately disclosed as part of operating cash flow
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Analyzing More Complex Situations
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Using a Spreadsheet
Worksheet Procedure
Direct Presentation Method
Indirect Method
Summary of Reconciling
Adjustments
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Using a Spreadsheet
 The spreadsheet approach is useful because
it:
 provides an organized format for documenting the
preparation process
 facilitates review and evaluation by others
 provides proofs of accuracy
 formally keeps track of the changes in balance
sheet accounts and ensures that all accounts are
explained
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Summary of Reconciling Adjustments
 To prepare the cash flow statement, it is necessary
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to convert the accrual basis earnings to the cash
basis and to trace other cash flows that caused
changes in the asset and equity structure of the
reporting enterprise
Basically, there are three types of adjustments that
must be made to the accrual basis accounts:
 accruals must be “backed out” of the monetary
asset and liability accounts to determine the
cash inflows and outflows for operations during
the period
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Summary of Reconciling Adjustments (cont.)
 the effects of interperiod allocations of costs
and revenues must be reversed
 certain transactions, the net effects of which
are included in net income, must be reclassified
as investing or financing activities
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