The statement of cash flows explains changes in cash resources by separating operating, investing, and financing activities. To prepare a statement of cash flows, the preparer connects accrual income and comparative balances to the transactions underlying each movement.
Under U.S. generally accepted accounting principles (GAAP), the reconciliation includes cash, cash equivalents, restricted cash, and restricted cash equivalents. Beginning and ending totals must include the same categories, even when the balance sheet presents them in separate captions.
- Operating activities cover ordinary receipts and payments associated with generating income, subject to the applicable classification rules.
- Investing activities cover acquiring and disposing of productive assets, investments, and loans made to other entities.
- Financing activities cover obtaining capital from owners and creditors, returning capital, and paying dividends.
- When no exchange-rate effect exists, adding operating, investing, and financing cash flows to the beginning cash total produces the ending cash total.
- When applicable, the exchange-rate effect on included cash balances appears separately from the three activity sections.
Common mistakes
- Maturity measured from issuance. Rejecting a Treasury bill acquired with 30 days remaining uses the wrong date; acquisition-date maturity and the other cash-equivalent criteria control.
- Expense counted twice. Adding $7,000 credit-loss expense while using the $16,000 net-receivable increase overstates operating cash by $7,000 in the receivables illustration.
- Current means operating. A $3,000 increase in dividends payable affects the dividend-payment calculation; inserting it in operating cash creates an unsupported adjustment.
Bottom line
- Reconcile beginning and ending cash, cash equivalents, restricted cash, and restricted cash equivalents using consistent categories.
- Cash-equivalent maturity is measured from acquisition, generally three months or less, together with liquidity, convertibility, and insignificant value-change risk.
- The indirect method removes noncash income effects and investing or financing gains and losses, then adjusts relevant operating balances.
- Exclude acquisitions, noncash movements, dividends payable, and debt classifications from ordinary operating working-capital adjustments.
Exam shortcut
Establish the combined beginning and ending cash totals before computing activity sections. Circle restricted balances and test short-term investments using the acquisition date. Build equipment cost, accumulated depreciation, debt, and dividends-payable rollforwards before treating any balance change as cash. Mark each income adjustment separately from the related cash transaction. For a disposal, calculate carrying amount, gain or loss, and proceeds as three distinct amounts.
The full lesson (about 7,118 words, 47 min read) adds 3 worked examples, all 5 common mistakes, a self-check, free in the app.
Learning objectives
- I.A5
Browse all free CPA FAR lessons or jump into free CPA FAR practice questions.