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23rd Nov 2019
Cash Flow Statement
Flow statement
Periodic
Provides information regarding the liquidity of a firm
explains the reasons for increase or decrease in cash balance
from one balance sheet date to the next
classifies the reasons for the change as an operating, investing
or financing activity.
amount of net income in a period is usually different than the
amount of increase in cash in the same period (Accruals
Concept)
reconciles net income with cash flow from operations.
Financial statements are prepared under the Accruals Concept of
accounting which requires that income and expense must be recognized in
the accounting periods to which they relate rather than on cash basis. An
exception to this general rule is the cash flow statement whose main
purpose is to present the cash flow effects of transaction during an
accounting period.
Under Accruals basis of accounting, income must be recorded in the
accounting period in which it is earned. Therefore, accrued income must
be recognized in the accounting period in which it arises rather than in the
subsequent period in which it will be received. Conversely, prepaid income
must be not be shown as income in the accounting period in which it is
received but instead it must be presented as such in the subsequent
accounting periods in which the services or obligations in respect of the
prepaid income have been performed.
Expenses, on the other hand, must be recorded in the accounting period in
which they are incurred. Therefore, accrued expense must be recognized
in the accounting period in which it occurs rather than in the following
period in which it will be paid. Conversely, prepaid expense must be not be
shown as expense in the accounting period in which it is paid but instead it
must be presented as such in the subsequent accounting periods in which
the services in respect of the prepaid expense have been performed.
Accruals basis of accounting ensures that expenses are "matched" with
the revenue earned in an accounting period. Accruals concept is therefore
very similar to the matching principle.
Classification of Cash Flows
Direct Method
Income Statement items are converted to cash flows
individually
Indirect Method
Net income or loss is adjusted for accruals such as
accounts receivable and payable, and for non-cash
expenses such as depreciation
reconciliation of the accrual based and cash based
accounting
Comparison of Methods
Direct method of presentation calculates cash flow from
operations by subtracting cash disbursements to supplies,
employees, and others from cash receipts from customers.
The indirect method calculates cash flow from operations by
adjusting net income for non-cash revenues and expenses.
Most firms present their cash flows using the indirect method.
Net income
+ noncash expenses: depreciation, amortization,
uncollectible account expense,etc
+ loss on sale of asset
+ increases in current liabilities
+ decreases in current assets
- gain on sale of asset
- decrease in current liabilities
- increase in current assets
= Cashflow from operating activities
Noncash Expenses- Why non cash
added back
Noncash expenses, such as depreciation expense,
are added back – because they were deducted to
measure net income but did not require any cash
payment in the current period
They are not truly sources of cash, even though
they are associated with cash inflows but reversal
of an accrued expense
Here is a compilation of top nine problems on cash flow
statements along with its relevant solutions.
Problem 1:
The bank balance of a business firm has increased during the
last financial year by Rs.1,50,000. During the same period it
issued shares of Rs.2,00,000 and redeemed debentures of
Rs.1,50,000. It purchased fixed assets for Rs.40,000 and
charged depreciation of Rs.20,000. The working capital of the
firm, other than bank balance, increased by Rs.1,15,000 during
the period. Calculate the profit of the firm for the year.
=
Problem 2:
Solution:
1,50,000 = Profit + 2,00,000 – 1,50,000 – 40,000 + 20,000 –
1,15,000
∴ Profit = Rs.2,35,000
Problem 2:
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