20.2.1. Differences Between IFRS and ASPE

There are differences in some of the reporting items between IFRS and ASPE. For example, ASPE has mandatory disclosures as follows:

• cash dividends received and interest received or paid if reported in net income – operating section

• interest or cash dividends debited to retained earnings – financing section

• Cash paid income taxes are often reported separately but it is not a reporting requirement.

For IFRS, there are policy choices that, once made, should be applied consistently:

• interest received – choice of operating or investing section

• interest paid – choice of operating or financing section

• dividends received – choice of operating or investing section

• dividends paid – choice of operating or financing section

• cash paid income taxes – separately reported

For simplicity, this chapter will use the following norms for both IFRS and ASPE:

• interest received – operating section

• interest paid – operating section

• dividends received – operating section

• dividends paid – financing section

• income taxes paid – separately reported

As illustrated above, when using the indirect method, the sum of the non-cash adjustments to net income and changes to non-cash working capital accounts result in the total cash flows in (out) from operating activities. The other two activities for investing and financing follow. Any non-cash transactions occurring in the investing or financing sections are not reported in a statement of cash flows. Instead, they are disclosed separately in the notes to the financial statements. Examples of non-cash transactions would be an exchange of property, plant, or equipment for common shares, or the conversion of convertible bonds payable to common shares and stock dividends. If the transaction is a mix of cash and non-cash, the cash-related portion of the transaction is reported in the statement of cash flows with a note in financial statements detailing the non-cash and cash elements. The final section of the statement reconciles the net change in cash flows of the three activities, with the opening and closing cash and cash equivalents balances taken from the balance sheet.

20.2.2. Preparing a Statement of Cash Flows: Indirect Method

Presented below is the balance sheet and income statement for Watson Ltd.

Additional information:

• The trading investment does not meet the criteria to be classified as a cash equivalent (see section 20.8 Specific Items for a discussion on cash equivalents) and no purchases or sales took place in the current year.

• An examination of the intangible assets sub-ledger revealed that a patent had been sold in the current year. The intangible assets have an indefinite life.

• No long-term investments were sold during the year.

• No buildings or patents were purchased during the year.

• There were no other additions to the long-term note payable during the year.

• Common shares were sold for cash. No other share transactions occurred during the year.

• Cash dividends were declared and paid.

• The note receivable maturity date is January 31, 2021, and was for a sale.

The statement of cash flows is the most complex statement to prepare. This is because preparation of the entries requires analysis of multiple accounts. Moreover, the transactions resulting in cash inflows are to be differentiated from the transactions resulting in cash outflows for each account. Preparing a statement of cash flows is made much easier if specific sequential steps are followed. Below is a summary of those steps.

• Complete the statement headings.

• Operating activities section – record the net income/(loss).

• Adjust out any non-cash line items reported in the income statement to remove them from the statement of cash flows. Examples of these are depreciation, amortization, and most gains or losses such as gains/losses from the sale of assets, gain/loss from redemption of debt, impairment losses, and fair value changes reported in net income.

• Record the description and change amount for each non-cash working capital account (current assets and current liabilities) except for the current portion of long-term debt line item since it is not a working capital account. Subtotal the operating activities section.

• Investment activities section – using T-accounts or other techniques, determine the change for each non-current (long-term) asset account. Analyze and determine the reason for the change(s). Record the reason and change amount(s) as cash inflows or outflows.

• Financing activities section – add back to long-term debt any current portion identified in the SFP/BS for both years, if any. Using T-accounts, or other techniques, determine the change for each non-current (long-term) liability and equity account. Analyze and determine the reason for the change(s). Record the reason and change amount(s) as cash inflows or outflows. One anomaly occurs with pension benefit liability. This liability is non-current, but it is not a financing activity as its nature is to benefit employees. For this reason, any change in funding for the pension liability, even though classified as non-current, is to be reported in operating activities.

• Subtotal the three sections. Record the opening and closing cash, including cash equivalents, if any. Reconcile the opening balance plus the subtotal from the three sections to the closing balance to ensure that the accounts balance correctly.

• Complete any required disclosures.

Here is a summary of the steps above, labelled with a key word or phrase for you to remember:

1. Headings

2. Record net income/(loss)

3. Adjust out non-cash items

4. Current assets and current liabilities changes

5. Non-current asset accounts changes

6. Non-current liabilities and equity accounts changes

7. Subtotal and reconcile

8. Disclosures

Applying the Steps:

Step 1. Headings:

Step 2. Record net income/(loss):

As illustrated in step 3 below.

Step 3. Adjustments:

Enter the amount of the net income/(loss) as the first amount in the operating activities section. Next, review the income statement and select all the non-cash items. Look for items such as depreciation, depletion, amortization, and gains or losses (such as with the sale or disposal of assets). In this case, there are two non-cash items to adjust from net income. Record them as adjustments to net income in the statement of cash flows.

Step 4. Current assets and liabilities:

Calculate and record the change between the opening and closing balances for each non-cash working capital account as shown below (with the exception of the current portion of long-term notes payable, which is netted with its respective long-term notes payable account) as shown below:

Cash inflows to the company are reported as positive numbers while cash outflows are reported as negative numbers using brackets. How does one determine if the amount is a positive or a negative number? A simple tool is to use the accounting equation to determine whether cash is increasing as a positive number or decreasing as a negative number. Recall the accounting equation:

This must always remain in balance. This equation can be applied when analyzing the various accounts to record the changes. For example, accounts receivable has increased from $165,000 to $249,510 for a total increase of $84,510. Using the accounting equation, this can be expressed as:

Expanding the equation a bit:

If accounts receivable INCREASES by $84,510, then this can be expressed as a black up-arrow above the account in the equation:

Holding everything in the equation constant, except for cash, if accounts receivable INCREASES, then the effect on the cash account must have a corresponding DECREASE in order to keep the equation balanced:

If cash DECREASES, then it is a cash outflow and the number must be negative with brackets as shown in the statement above.

Conversely, when analyzing liability or equity accounts, the same technique can be used. For example, an increase in account payable (liability) of $143,000 will affect the equation as follows:

Again, holding everything else constant except for cash, if accounts payable INCREASES as shown by the black up-arrow above, then cash must also INCREASE by a corresponding amount in order to keep the equation in balance.

If cash INCREASES, then it is a cash inflow and the number will be positive with no brackets as shown in the statement above.

Step 5. Non-current asset changes:

The next section to complete is the investing activities section. The analysis of all of the non-current assets accounts must also take into account whether there have been any current year purchases, disposals, or adjustments as part of the analysis. The use of T-accounts for this type of analysis provides a useful visual tool to help understand whether the changes that occurred in the account are cash inflows or outflows, as shown below.

There are four non-current asset accounts: long-term investments, land, buildings, and intangible assets. The land account had no change, as there were no purchases or sales of land. Analyzing the investment account results in the following cash flows:

Long-term investment
	–
	??			= purchase of investment
	30,750

Additional information in note #3 above stated that there were no sales of long-term investments during the year, the entry would have been for a purchase:

Cash paid for the investment was therefore $30,750.

Analysis of the buildings account is a bit more complex because of the effects of the contra account for accumulated depreciation. In this case, the buildings account, and its contra account, must be merged together since the SFP/BS reports only the net carrying amount. Analyzing the buildings account results in the following cash flows:

Building (net of accum. depr.)
	325,000
		43,000		current year accum. Depr.
		50,000		= X sale of building
	232,000

Additional information note # 4 states that no buildings were purchased so the balancing amount of $50,000 must be for a sale of a building. Since there was a gain from the sale of buildings, the entry would have been:

Cash proceeds were therefore $55,000.

The sale of the patent is straightforward since there were no other sales, purchases, or amortization in the current year (as stated in steps 2 and 4).

Step 6. Non-current liabilities and equity changes:

There are five long-term liability and equity accounts: long-term notes payable, preferred shares, common shares, contributed surplus, and retained earnings. The preferred shares and contributed surplus accounts had no changes to report. Note that just because an account balance has no change during the year, this does not necessarily mean that there were no transactions. For example, old shares could be retired and new shares issued for the same face value. These transactions would need to be reported in the cash flow statement, even though the net change in the account is zero.

Analyzing the long-term notes payable account results in the following cash flows:

Long-term note payable
	325,000			the sum of both the current and long-term amounts
			19,000	X = repayment
	306,000			the sum of both the current and long-term amounts

Since there were no other transactions stated in the additional information note # 5 above, the entry would have been:

Cash paid was therefore $19,000.

Note how the current portion of long-term debt has been included in the analysis of the long-term note payable. The current portion line item is a reporting requirement relating to the principal amount owing one year after the reporting date. As it is not actually a working capital account, it is omitted from the operating section and included with its corresponding long-term liability account in the financing activities. For example, the opening balance of $325,000 above is the sum of the current portion ($45,000) plus the long-term portion ($280,000). Similarly, the ending balance of $306,000 is the sum of the current portion ($60,000) plus the long-term portion ($246,000).

The common shares and retained earnings accounts are straightforward and the analysis of each is shown below.

Common shares
		680,300
		182,200		X = share issuance
		862,500

Since there were no other transactions stated in the additional information note #6 above, the entry would have been:

Cash received was therefore $182,200.

Retained earnings
		50,000
		77,000		net income
	X = 42,590			dividends paid
		84,410

The additional information note #7 stated that cash dividends were declared and paid, so the entry would have been:

Cash paid was therefore $42,590.

Step 7. Subtotal and reconcile:

The three activities total a net increase in cash of $57,500. When added to the opening cash balance of $250,000, the resulting total of $307,500 is equal to the ending cash balance for the year ending December 31, 2020. This can be seen in the completed statement of cash flows following step 8.

Step 8. Required disclosures:

The statement of cash flows using the indirect method must separately disclose the cash flows for:

• Interest paid

• Interest received

• Dividends received (dividends paid are reported in the financing section)

• Cash paid income taxes

• Non-cash transactions that may have occurred in the current year.

If not too lengthy, these items can be disclosed in the notes or at the bottom of the statement. The cash received for dividend income and interest income was taken directly from the income statement since no accrual accounts exist on the balance sheet for these items. Cash paid for interest charges and income taxes are calculated on the basis of an analysis of their respective liability accounts from the balance sheet and expense accounts from the income statement.

Below is the completed statement of cash flows using the indirect method with required disclosures for Watson Ltd., for the year ending December 31, 2020:

Disclosures:
Cash paid for income taxes		$	38,880
()
Cash paid for interest charges			11,400
()
Cash received for dividend income			3,000

Note that the interest income of $2,000 reported in the income statement is not included in the additional disclosures shown above. This is because the interest income was accrued as an adjusting entry regarding the trading investments, so it was not a cash-received item.

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20.3.1. Preparing a Statement of Cash Flows: Direct Method

As with the indirect method, preparing a statement of cash flows using the direct method is made much easier if specific steps are followed in sequence. Below is a summary of those steps to complete the operating section of the statement of cash flows using the direct method:

Direct Method Steps:

• Complete the headings and categories section of the operating activities. The example below includes seven categories based on the nature of the revenue and expenses.

• Create three additional columns: Income Statement (I/S) Accounts, Changes to Working Capital (WC), and Accounts and Net Cash Flows In (Out).

• Starting with the top of the income statement, record each income statement line item amount to the most appropriate direct method category in the I/S Accounts column. These would include sales, cost of goods sold, operating expenses, non-operating revenue, and various expenses items. Any non-cash items are also recorded, but only as memo items in the column. Examples of these would be depreciation, amortization, and most gains or losses. Such as gains or losses from the sale of assets, gains or losses from the redemption of debt, impairment losses, and from fair value changes reported in net income. The I/S Accounts column total must be equal to net income.

• Under the Changes to Working Capital Accounts, record the net change amount for each non-cash working capital account (current assets and current liabilities) except for the "current portion of long term debt" line item. As it is not a working capital account, it is added back to its corresponding long-term liability. Also, record as an adjustment any additional non-cash items found in net income arising from the analysis of the non-current asset, liability, and equity accounts. The obvious non-cash items were recorded as memo items only in Step 3, but other non-cash items can be uncovered when analyzing the non-current assets, liabilities, and equity accounts. When these are discovered, they must be recorded as an adjustment to net income in this column.

• Under the Net Cash Flows In (Out), calculate the net cash flows amount for each direct method category.

• Calculate the subtotal of the operating activities section and transfer the information to the statement of cash flows operating activities section.

Using the financial statements from Watson Ltd. presented previously, we will apply the steps below:

Applying the Steps:

Step 1 and Step 2. Headings, categories, and three additional columns.

Step 3. Record each income statement line item amount to its respective direct method category under the I/S Accounts column (non-cash items are memo items only):

Step 4. Record the net change amount for each non-cash working capital account, except cash (also, record any adjustment amounts to net income resulting from analysis of non-current accounts):

Note how items 13 and 17 on the operating activities statement, regarding the trading investments, cancel each other out. This is because the interest income from the trading investment was accrued and not actually received in cash.

In this simple example, no adjustments to net income resulting from analysis of non-current assets, liabilities, and equity are identified. However, this situation will be illustrated in the comprehensive example later in this chapter.

The change in each working capital account can be a positive or a negative cash flow (using brackets). To ensure that the cash flow is correctly identified as positive or negative, apply the principles using the accounting equation explained earlier:

Refer to the earlier section in this chapter for more details regarding this technique.

Step 5 and Step 6. Calculate the net cash flows amount for each category and calculate the subtotal for the operating activities section (transfer the information to the statement of cash flows):

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A video is available on the Lyryx web site. Click Here to view the video.

A video is available on the Lyryx web site. Click Here to view the video.

20.7.1. Preparing the Statement of Cash Flows: Indirect Method

Indirect Method Steps:

Following the steps listed above, prepare a statement of cash flows using the indirect method. Details are provided below for each step, followed by the completed statement of cash flows.

Notes to the Solutions and Details About Calculations:

Step 1. Headings:

Insert headings and subheadings, leaving spaces within each section to record the relevant line items resulting from the subsequent steps.

Step 2. Record net income/(loss):

Net income (and not comprehensive income) is the starting point for a statement of cash flows with the indirect method. Comprehensive income will become relevant if any of the AFS investments are actually sold. Recall that upon sale, any unrealized gains or losses previously recorded to OCI will be realized and moved to retained earnings from AOCI.

Step 3. Adjustments:

When reviewing the income statement, non-cash items for depreciation, loss on sale of machinery, and realized gain on sale of AFS investments are reported. However, since this is a more complex example, there could be other hidden non-cash items that will become apparent when analyzing the non-current asset, liability, and equity accounts. Leave some space in this section in case other non-cash items are discovered in the accounts analysis.

Step 4. Current assets and liabilities:

Continue to use the accounting equation, A = L + E, to determine if the change amount for each non-cash working capital account is a positive number or a negative number (requiring a bracket).

Step 5. Non-current asset changes:

Analyze all the non-current asset accounts to determine the reasons for the changes in the accounts. Additional information taken from the various accounting records has been provided. Items 3, 6, and 7 pertain to non-current assets so this information will be incorporated into the step 5 analysis.

1. AFS investment (OCI):

   Long-term AFS investments
   	80,000
   			50,000	sale of investment
   	76,000			purchase of AFS investment
   	X = 44,000			increase in fair value (OCI)
   	150,000
   AOCI, investments
   			24,000
   			44,000	increase in fair value (OCI)
   	3,000			remove realized gain on sale
   			65,000

   Additional information in note # 3 states that $50,000 of AFS investments (fair value = carrying value) was sold for $50,000 cash, so there's no gain or loss on the actual sale. However, the original cost was $47,000, so there is an accumulated unrealized gain of $3,000 () for the sold investment that was reclassified from OCI/AOCI to net income. This is confirmed by reviewing the income statement. This non-cash entry has already been adjusted in operating activities in Step 3, so no further action is required. Entry for the sale:

   

   Entry to reclassify:

   

   Note # 3 also states that there was also a cash paid investment of $76,000. The T-account requires another debit for $44,000 to balance properly. This must be for fair value changes and that is confirmed by reviewing the comprehensive income statement. This non-cash entry is not included in the income statement so no further action is necessary.

   Analysis result: enter the cash amounts for the sale ($50,000) and the purchase of AFS investments ($76,000) highlighted in red in the investing activities section of the statement of cash flows.

2. Land:

   Land
   	200,000
   	X = 180,000			purchase of land
   	380,000

   Additional information in note # 6 states that land was purchased for cash. There is no other information about the land account so the balancing amount of $180,000 must be the purchase price of the land. Entry for the purchase:

   

   Analysis result: enter the cash amount for the purchase of land ($180,000) highlighted in red in the investing activities section of the statement of cash flows.

3. Machinery:

   Machinery
   	1,500,000
   			100,000	sale of machinery
   	X = 300,000			purchase of machinery for shares
   	1,700,000
   Accumulated depreciation
   			400,000
   	80,000			sale of machinery
   			43,000	X = current year depreciation
   			363,000

   Additional information note # 7 states that there was a loss from the sale of machinery of $15,000 that originally cost $100,000. The carrying value at the time of the sale was $20,000. The cash amount for the sale would therefore be $5,000 (). The accumulated depreciation for the sold machinery would be $80,000 (). Entry for the sale:

   

   Accumulated depreciation requires another $43,000 credit to balance properly. This must be for the current year depreciation expense and that is confirmed by reviewing the income statement. This non-cash entry has already been adjusted in operating activities in Step 3, so no further action is required. Note # 7 also stated that additional machinery was purchased in exchange for common shares. The balancing amount of $300,000 would account for this non-cash transaction which is not included in the SCF except as a supplemental disclosure required for non-cash items.

   Analysis result: enter the cash amount for the sale of machinery ($5,000) highlighted in red in the investing activities section of the statement of cash flows.

Step 6. Non-current liabilities and equity changes:

Analyze all the non-current liability and equity accounts to determine the reasons for the changes in the accounts. Additional information taken from the various accounting records has been provided. Items 1, 2, 4, 5, 8, and 9 pertain to non-current liabilities and equity so this information will be incorporated into the step 6 analysis.

4. 6% bonds payable:

   6% Convertible bonds payable
   			750,000
   	X = 750,000			conversion of bonds to shares
   			–

   Additional information note # 5 states that these bonds were converted into common shares in 2020. The equity portion for the conversion rights of $35,000 will also be removed from the contributed surplus account. Entry for the conversion:

   

   This is a non-cash entry which is not included in the SCF except as a supplemental disclosure required for non-cash items.

   Analysis result: no cash entries to record.

5. 7.2% bonds payable:

   7.2% Bonds payable
   			–
   			452,000	issuance of bonds
   			1,000	X = amortized discount
   			453,000

   Additional information note # 1 states that bonds with a face value of $500,000 were issued for cash of $452,000. The discount amount would be $48,000 () which will be amortized. Entry for the bond issuance:

   

   The balancing amount of $1,000 must therefore be for amortization of the discount which will be included in net income as part of interest expense of $30,000. This $1,000 non-cash amount should be adjusted from net income in operating activities because it was not done in Step 3.

   Analysis result: enter the cash amount for the bond issuance ($452,000) and adjust the $1,000 amortization expense highlighted in red in the financing activities section of the statement of cash flows.

6. Deferred income tax payable:

   Deferred Income Tax Payable
   			50,000
   	X = 12,000			reduction of taxes
   			38,000

   There is no additional information regarding this account. The balancing amount of $12,000 must be for a deferred income tax recovery which is confirmed by a review of the income statement. This non-cash entry was included in net income but not adjusted in Step 3, so it should be adjusted in the operating section now.

   Analysis result: enter the non-cash amount for the deferred tax recovery ($12,000) highlighted in red in the operating activities section as an adjustment to net income.

7. Accrued pension benefit liability:

   Accrued Pension Benefit Liability
   			75,000
   			20,000	actuarial revaluation
   	X = 10,000			funding amount greater than
   				pension expense
   			85,000
   AOCI, Pension Benefits
   	20,000
   	20,000			actuarial revaluation
   	40,000

   Additional information note # 9 states that this liability was increased by $20,000 due to an actuarial revaluation. This non-cash adjusting entry to OCI/AOCI was not included in net income so it will be omitted from the SCF. Note # 9 also states that the remaining difference was due to the difference between the funding (cash paid) and the pension expense. Entries for pension benefit:

   

   The pension expense amount is not known but the funding (cash) amount is known to be greater than the pension expense by $10,000. Even though this is a non-current liability, it's purpose is to benefit employees and not as a source of financing cash flow. For this reason, it is more appropriate to record this non-current liability reduction as an operating activity instead of a financing activity.

   Analysis result: enter the cash difference amount ($10,000) highlighted in red as an operating activity item for the reduction in the pension liability.

8. Common shares:

   Common shares
   			500,000
   			300,000	machinery in exchange for shares
   			785,000	6% bonds converted
   	430,000			shares repurchase
   			55,000	options exercise for shares
   			1,210,000
   Contributed Surplus – Stock Options
   			50,000
   	15,000			options exercised for shares
   			27,000	X = compensation expense (non-cash)
   			62,000

   Additional information note # 8 states that shares with an original price of $430,000 were retired for $485,000 cash. The difference is to be debited to retained earnings. Entry for shares repurchase:

   

   Additional information note # 4 states that $15,000 of stock options were exercised along with an additional $40,000 in cash for common shares. The difference in the contributed surplus account was due to compensation expense. Entry for exercise of options:

   

   Entry for compensation expense:

   

   It is now evident that $27,000 of the compensation expense included in net income in salaries and benefits line item is a non-cash transaction that was not adjusted in Step 3. This amount should therefore be adjusted out of net income in operational activities now.

   Analysis result: enter the cash amount for the shares repurchase ($485,000) and the cash amount for stock options ($40,000) highlighted in red in the investing activities section of the statement of cash flows. Also, enter the adjusting entry ($27,000) highlighted in red in the operating activities section of the statement of cash flows.

9. Retained earnings:

   Retained earnings
   			46,000
   			345,000	net income
   	55,000			stock options
   	X = 144,000			dividends paid
   			192,000

   Additional information note # 2 states that dividends were declared and paid but no amount given. The balancing amount to retained earnings of $144,000 must therefore be the amount of the dividend. Entry for dividends paid:

   

   Analysis result: enter the dividend amount ($144,000) highlighted in red in the financing activities section of the statement of cash flows.

Step 7. Subtotal and reconcile:

Calculate subtotals for each section and also for net cash flows. Reconcile the net amount to the opening and closing cash balances from the balance sheet.

Step 8. Required disclosures:

Prepare the additional disclosures for cash paid interest and income taxes.

Below is the prepared statement of cash flows based on the steps discussed above.

Disclosures:

Cash paid for income taxes

Cash paid for interest charges

Machinery ($300,000) was purchased in exchange for shares.

Six percent convertible bonds ($750,000), and contributed surplus rights ($35,000), were converted to common shares.

Stock options ($15,000) and cash ($40,000) were exercised for common shares.

20.7.2. Operating Activities Section: Direct Method

We will once again use the comprehensive illustration above for Ace Ltd. to demonstrate the completion of the operating activities section using the direct method. The first example explained below demonstrates how to prepare a direct method statement on its own. The second example demonstrates a quick technique to convert an already prepared indirect statement of cash flows into a direct method format.

Direct Method Steps:

In this example, steps 1 and 2 are self-explanatory. Steps 3, 4, and 5 are represented by entries in each of the columns in the schedule above. Note that this example is more complex as some non-cash costs were embedded with other income statement expenses initially treated as cash items and left unadjusted. There was also a reduction in the non-current pension liability which was more appropriately reported as an operating activity. These items were discovered when the analysis of the non-current assets (investing activities), liabilities and equity (financing activities) were completed. As a result, there are four additional adjusting entries (e, f, g and h) that must be adjusted in Step 4 of the operating section above (highlighted in blue).

LO 1: Describe the statement of cash flows (SCF) in accounting and business.

The SCF reports on how a company obtains and utilizes its cash flows and how it reconciles with the opening and ending cash and cash equivalent balances of the statement of financial position. It is separated into operating, investing, and financing activities, and the combination of positive and negative cash flows from within each activity can provide important information about how a company is managing its cash flows. Large differences between reporting net income and the net cash flows from operations reduce the quality of earnings and the reliability of the financial statements, creating the need for further evaluation into the reasons for the differences.

LO 2: Explain the purpose of the statement of cash flows and the two methods used.

The statement of cash flows provides the means to assess a business's capacity to generate cash and to determine the source of their cash flows. The statement combines with the SFP/BS to evaluate a company's liquidity and solvency, which represents its financial flexibility. This information, based on past events, can be used to predict the future financial position and cash flows of the company. It can also shed light on a company's quality of earnings and whether there may be a disconnect between report earnings and net cash flows from operating activities.

The SCF can be prepared using either the indirect or direct method. With the indirect method, the statement is presented in three distinct sections: operating activities (net income, current assets and liabilities), investing activities (non-current assets), and financing activities (long-term debt and equity), which follows the basic structure of the SFP/BS classifications. The changes between the opening and closing balances of the SFP/BS items are reported in the SCF as either cash inflows or cash outflows. The three sections net to a single net cash inflow or outflow, when combined with the cash and cash equivalent opening balance results in the same amount as the ending balance reported on the SFP/BS. The only difference between the methods is the categorization of cash flows by nature in operating activities, as occurs with the direct method. The investing and financing sections are identical for both methods.

There are some reporting differences between IFRS and ASPE regarding interest received and paid, dividends received and paid, and income taxes paid. For simplicity's sake, the chapter focuses on reporting interest received and paid, dividends received in operating activities, and dividends paid in financing activities. Income taxes paid can be separately reported for ASPE but it is only mandatory for IFRS. Whereas, both accounting standards require that non-cash transactions be reported in the notes to the financial statements. Where transactions involve some cash flows, this portion of the transaction is included in the SCF with supplementary disclosures of the transactions in the notes.

When preparing a statement of cash flows using the indirect method, the operating activities section begins with the net income/loss amount from the income statement. Entries for non-cash items such as depreciation, depletion, amortization, and gains/losses from sale/disposal of non-current assets are shown as adjustments to net income in order to remove the effects of non-cash items. The remainder of the operating activities section lists each non-cash working capital account change from opening to closing balances and reports as either cash flow in or out (cash flow out is prefixed by a minus sign). The investing activities are the change amounts between the opening and closing balances for any non-current assets such as long-term investments, property, plant, equipment, and intangible assets. Each line item from the non-current assets section of the SFP/BS is analyzed to determine if any non-current assets were purchased or sold during the year, and to report the cash paid or received. These amounts are reported as cash flows in or out. The financing section uses the same method as the investing for non-current liabilities and equities, such as any long-term debt, issuance or repurchase of shares for cash and dividends paid. These amounts are reported as cash flows in or out. Finally, the three sections are netted to a single amount and added to the cash and cash equivalent opening balance. The resulting sum should match the ending cash and cash equivalent balance reported in the SFP/BS, and the required disclosures (as described above) need to be prepared.

LO 3: Describe the statement of cash flows using the direct method and explain the difference in format from the indirect method.

With the direct method, the operating activities section is composed of major categories of cash flows in and out (determined by nature). Categories can include cash received from sales, cash paid for goods and services, cash paid to or on behalf of employees, as well as separate categories for interest received and paid and dividends received.

To prepare a statement of cash flows using the direct method, the operating activities section begins with the income statement where each line item is assigned to the most appropriate category as either a positive cash flow in or a negative cash flow out. Non-cash items are recorded as a memo item only. Next, each non-cash working capital account change between its opening and closing balance is then assigned to the most appropriate category as either a positive or negative cash flow. The net cash flow from each category, and for operating activities, is calculated. The methods used to prepare the investing and financing activities are the same as with the indirect method.

LO 4: Describe how the results from the statement of cash flows are interpreted.

The SCF, using the indirect method, is the most commonly used format in business, and the most important section within it is the operating activities. This is because it shows the cash flows in or out that result from the company's daily operations, which allows us to determine if the company is solvent. If cash flows in this section are negative, then management must determine if this is due to a temporary condition or if fundamental changes are needed to better manage the collections of accounts receivables or levels of unsold inventory. In any case, if a company is in a negative cash flow position from operating activities, it will usually either increase its debt through borrowing, increase its equity by issuing more shares, or sell off some of its assets. If any of these steps are taken, they will be reported as cash inflows from either the investing or financing sections. While none of these options are ideal, they can be used for the short-term, but they are unsustainable in the long-run. Positive cash flows from operating activities must also be evaluated to determine if they are sustainable and to ensure that they will be consistent going forward.

LO 5: Describe the required disclosures for the statement of cash flows.

The main disclosures identified in this chapter included an explanation of the changes in the opening and closing cash balance (including cash equivalents) as well as the components and policy used to determine them. Cash flows in and out are classified as operating, investing, and financing–using either the indirect or direct method. The major classes of cash flows in and out are also to be separately reported within each of the three sections. Cash flows from interest, dividends, and income taxes are separately disclosed as explained above, while non-cash transactions require supplementary disclosure.

LO 6: Describe the types of analysis techniques used for the statement of cash flows.

While the statement of cash flows may report a positive net income, this does not guarantee a positive cash flow for that period. Also, determining which activity the positive cash flows originate from is critical analytical information for the stakeholders. At the end of the day, operating activities must be able to sustain a positive cash flow for the company to survive. There are ratios that assess the operating activities cash flow, but trends or industry standards are also needed in order for the results to be informative. Two of the common ratios used are the current cash debt coverage ratio and the cash debt coverage ratio. Free cash flow analysis is another technique used, and it calculates the remaining cash flow from the operating activities section after deducting cash spent on capital expenditures, such as purchasing property, plant and equipment. Some companies also deduct cash paid dividends. The cash flow remaining is available to the company for strategies such as expansion, repayment of long-term debt, or down-sizing share holdings to improve the share price, reduce the amount of dividends to pay, and to attract future investors.

LO 7: Review and understand a comprehensive example of an indirect and direct statement of cash flows that includes complex transactions from intermediate accounting courses.

Examples of how to prepare a SCF using the indirect and direct method are explained previously in the chapter. The examples include complex transactions including investments classified as available for sale, accrued pension liabilities, deferred income taxes, bonds issued as a discount with amortization, bonds converted to shares, stock options, and re-acquisition of shares.

LO 8: Discuss specific items that affect the statement of cash flows.

Several issues are identified, and discussed, in this section in terms of their effect on the SCF. These include what makes up cash equivalents, restricted cash or cash equivalents, bank overdrafts, discontinued operations, impairments of assets, investments in associates, comprehensive income, netting of old and new liabilities, leases, complex financial instruments, and stock splits and dividends.

LO 9: Summarize the differences between ASPE and IFRS regarding reporting and disclosure requirements of the statement of cash flows.

The differences are identified throughout the chapter.

References

CPA Canada. (2016). CPA handbook. Toronto, ON: CPA Canada.