Page 630 - Accounting Principles (A Business Perspective)

16. Analysis using the statement of cash flows

managed upward by recognizing earnings prematurely (or falsely) or by underestimating expenses such as
depreciation expense or bad debts expense.
In addition to the challenges of verifying the accuracy of financial statements, a career in auditing provides a

variety of options. Students can work for global auditing firms or small local firms, choose to travel frequently or on
a limited basis, and decide to live in any geographic area around the world. A career in auditing also provides an
excellent springboard for future opportunities. Companies realize that their auditors can be a valuable part of the
management team. Auditors have expertise about the firm, its industry, and its accounting practices. Auditors
commonly leave the auditing profession to work for one of their many clients.
The income statement, statement of stockholders' equity (or statement of retained earnings), and the balance
sheet do not answer all the questions raised by users of financial statements. Such questions include: How much

cash was generated by the company's operations? How can the Cash account be overdrawn when my accountant
said the business was profitable? Why is such a profitable company able to pay only small dividends? How much
was spent for new plant and equipment, and where did the company get the cash for the expenditures? How was
the company able to pay a dividend when it incurred a net loss for the year?
In this chapter, you will learn about the statement of cash flows, which answers these questions. The statement
of cash flows is another major required financial statement; it shows important information not shown directly in
the other financial statements.

Purposes of the statement of cash flows
In November 1987, the Financial Accounting Standards Board issued Statement of Financial Accounting
Standards No. 95, "Statement of Cash Flows". The Statement became effective for annual financial statements for
50
fiscal years ending after 1988 July 15. Thus, the statement of cash flows is now one of the major financial
statements issued by a company. The statement of cash flows replaced the statement of changes in financial
position, on which funds were generally defined as working capital. Working capital is equal to current assets
minus current liabilities.
The main purpose of the statement of cash flows is to report on the cash receipts and cash disbursements of an
entity during an accounting period. Broadly defined, cash includes both cash and cash equivalents, such as short-
term investments in Treasury bills, commercial paper, and money market funds. Another purpose of this statement
is to report on the entity's investing and financing activities for the period. As shown in Exhibit 126, the statement
of cash flows reports the effects on cash during a period of a company's operating, investing, and financing

activities. Firms show the effects of significant investing and financing activities that do not affect cash in a
schedule separate from the statement of cash flows.
Uses of the statement of cash flows

The statement of cash flows summarizes the effects on cash of the operating, investing, and financing
activities of a company during an accounting period; it reports on past management decisions on such matters as
issuance of capital stock or the sale of long-term bonds. This information is available only in bits and pieces from

50 FASB, Statement of Financial Accounting Standards No. 95, "Statement of Cash Flows" (Stamford, Conn.,
1987). Copyright by the Financial Accounting Standards Board, High Ridge Park, Stamford, Connecticut 06905.

U.S.A. Quoted (or excerpted) with permission. Copies of the complete document are available from the FASB.

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