THE FINANCIAL STATEMENTS PREPARATION

PART 1. THE FINANCIAL STATEMENTS

I. Financial Statements
A. The statement of financial position presents an organized list of assets, liabilities, and equity at a particular point
in time.
B. The statement of profit or loss and other comprehensive income
1. The purpose of the statement of profit or loss and other comprehensive income is to summarize the income-
generating transactions that caused shareholders’ equity (retained earnings and other reserves) to change
during the period.
2. Presented as either:
(a) a single, continuous statement of profit or loss and other comprehensive income, or
(b) a separate statement of comprehensive income immediately following a separate statement of profit or
loss.
C. The statement of cash flows summarizes the transactions that caused cash to change during the period.
D. The statement of changes in equity discloses the events that caused the various shareholders’ equity accounts to
change during the period.
E. The underlying assumption for the preparation and presentation of financial statements is the going concern
assumption.
F. There are three other assumptions that are useful in guiding the measurement and reporting of financial
statement information.
1. Economic entity assumption
2. Periodicity assumption
3. Monetary unit assumption
G. A reporting entity is defined as an entity that prepares financial statements and need not be a legal entity.
II. Recognition, Measurement, and Presentation and Disclosure Concepts
A. Recognition
1. An item should be recognized in the basic financial statements if it meets the definition of the item and the
following two conditions:
- Recognition provides relevant information about the item.
- Recognition provides faithful representation of the item.
2. Uncertainty in the existence and measurement of assets and liabilities and low probability of inflow or outflow
of benefits are some factors that indicate that recognition does not result in relevant information.
3. Revenue recognition recently changed due to the issuance of IFRS 15, which requires that revenue be
recognized at a point in time or over a period of time, depending on when a seller fulfills its performance
obligations of transferring the control of goods or services to customers for the amount the seller expects to be
entitled to receive in exchange for those goods or services. No revenue is recognized if it is not probable that
the seller will collect the amounts it is entitled to receive.
4. Expense recognition typically occurs in the period in which expenses are incurred to produce revenues.
B. Measurement
1. There are two main categories of measurement bases: historical cost and current value.
2. Current value is further categorized into value in use (for assets), fulfillment value (for liabilities), and fair value.
3. Value in use and fulfillment value are based on the present value of future cash flows discounted for the time
value of money.
4. Fair value is based on the price that would be received to sell assets or transfer liabilities.
5. Fair value can be measured using market, income, or cost approaches.
6. The IASB provides a framework for measuring fair value that is based on a hierarchy that prioritizes the inputs
of fair value measurement according to levels.
7. IFRS gives a company the option to report some or all of its financial assets at fair value.
C. Presentation and Disclosure
 1. Financial reports should include any information that could affect the decisions made by external users, subject
to the cost-effectiveness constraint.
2. Such information is disclosed using modifying comments, disclosure notes, and supplemental schedules and
tables.
3. The use of presentation and disclosure tools such as classification and aggregation can improve relevance and
faithful representation.
4. Income and expenses are included as part of profit or loss, except if relevance and faithful representation are
improved by including them as part of other comprehensive income.
5. Recycling of other comprehensive items to profit or loss is done only if relevance and faithful representation of
the statement of profit or loss is improved.
III. Capital and Capital Maintenance Concepts
A. Capital
1. A financial capital concept focuses on an entity’s invested money, and capital is defined as the entity’s net
assets (assets minus liabilities) or equity.
2. A physical capital concept focuses on the entity’s operating capability, and hence, capital is defined as the
entity’s productive capacity or units of output.
B. Capital Maintenance and Profit
1. Under a financial capital maintenance concept, profit is represented by an increase in the monetary units of
net assets, and price increases in net assets are treated as profits.
2. Under a physical capital maintenance concept, profit is represented by an increase in physical productive
capacity or operating capability during the period. Price changes in net assets are treated as changes in
physical productive capacity and are therefore treated as capital maintenance adjustments (equity) and not
profits.
IV. Evolving Accounting Standards
A. Two competing approaches for the recognition of revenues and expenses are (1) the revenue/expense approach
and (2) the asset/liability approach.
B. Under the revenue/expense approach, principles for recognizing revenues and expenses are emphasized, with
assets and liabilities recognized as necessary to make the statement of financial position reconcile with the
statement of profit or loss.
C. Under the asset/liability approach, principles for asset and liability measurement are emphasized, and revenues,
expenses, gains, and losses are recognized as necessary to make the statement of financial position reconcile
with the statement of profit or loss.

Part 2. The Statement of Financial Position

I. Usefulness
The statement of financial position provides information useful for assessing future cash flows, liquidity, and long-
term solvency.
II. Limitations
Assets minus liabilities, measured according to accounting standards, is not likely to be representative of the market
value of the entity (number of ordinary shares outstanding multiplied by price per share).
III. Classification of Elements
A. Assets are economic resources resulting from past events, which a company has control over.
And economic resources consist of rights and the potential to give rise to economic benefits.
1. Current assets include cash and all other assets expected to become cash or be consumed within one year or
the operating cycle, whichever is longer.
a. cash and cash equivalents
b. short-term investments
c. accounts receivable
d. prepaid expenses
e. inventories
 2. Noncurrent or long-term assets are those assets that are expected to provide benefits beyond the next year (or
operating cycle).
a. investments
b. property, plant, and equipment
c. intangible assets
d. other assets
B. Liabilities are present obligations arising from past events to transfer economic resources. The obligation to
transfer economic resources is defined as the existence of the potential to require a transfer of economic
resources from the company to another entity.
1. Current liabilities, in general, are expected to be satisfied within one year or the operating cycle, whichever is
longer.
a. accounts payable
b. notes payable
c. deferred revenues
d. accrued liabilities
e. current maturities of long-term debt
2. Noncurrent or long-term liabilities are obligations that will not be satisfied in the next year or operating cycle,
whichever is longer.
C. Shareholders' equity is the remaining interest in an entity’s assets after deducting liabilities. It comprises of issued
capital and retained earnings.
1. Issued capital represents the amounts invested by shareholders.
2. Retained earnings represent the accumulated net profit reported since the inception of the company and not
yet paid to shareholders.
Shareholders’ equity also includes:
3. Treasury shares: This represents a company's purchase (but not retirement) of its own shares.
4. Reserves such as capital reserve, translation reserve, hedging reserve, and other reserves arising from other
comprehensive income items that are not reported as part of net profit or loss.
D. There are more similarities than differences in statements of financial position prepared according to IFRS and those
prepared according to US GAAP. Some of the differences are as follows:
1. IAS No.1 specifies a minimum list of items that are to be presented in the statement of financial position, while
US GAAP does not.
2. IAS No. 1 does not prescribe the format of the statement of financial position, but statements of financial
position prepared using IFRS often report noncurrent assets and liabilities before current assets and liabilities.
Under US GAAP, current items are presented before noncurrent items.

Financial Disclosures
I. Disclosure Notes
A. Disclosure notes include certain required notes as well as notes fashioned to suit the disclosure needs of the
reporting enterprise.
B. The summary of significant accounting policies conveys valuable information about the company's choices from
among various alternative accounting methods.
C. A subsequent event is a significant development that takes place after the company's financial year-end but
before the financial statements are authorized to be issued.
D. Related-party transactions are those between the company and owners, management, families of owners or
management, affiliated companies, and other parties that can significantly influence or be influenced by the
company. The economic substance of related-party transactions should be disclosed, including dollar amounts
involved.

II. Management Discussion and Analysis

The management discussion and analysis provides a biased but informed perspective of a company's (a) operations,
(b) liquidity, and (c) capital resources.
III. Management's Responsibilities
A. Annual reports include a management's responsibility section or directors’ responsibility section which asserts the
responsibility of management and/or directors for the information contained in the annual report.
B. In the United States, the management’s responsibility section also asserts the responsibility of management in
assessing the effectiveness of the companies’ internal control over financial reporting.
IV. Auditor’s Report
A. The auditor’s report provides an independent and professional opinion about the fairness of the representations
in the financial statements.
B. The form and content of auditor’s reports depend on the requirements of the specific jurisdictions involved. The
auditor’s report presents the auditor’s opinion, describes the “key audit matters” which are significant areas of
focus of the audit, and explains why these key matters are significant and how they are addressed during the
audit. In the United States, the auditor’s report also contains the auditor’s opinion on the effectiveness of the
company’s internal control over financial reporting.
C. Some audits result in the need to issue an opinion other than an unqualified (or “clean”) opinion—qualified
opinion, adverse opinion, and disclaimer of opinion. An unqualified opinion can also contain an explanatory
paragraph for issues concerning lack of consistency, going concern, or emphasis of matter.
V. Compensation of Directors and Top Executives
A. In the United States, the proxy statement, which must be sent each year to all shareholders, serves as an
invitation to attend the company's annual meeting and as a means to vote on issues before the shareholders. The
proxy statement also contains disclosures on compensation to directors and executives.
B. In other jurisdictions, such as in the United Kingdom, listed companies are required to disclose their directors’
remuneration in the annual report, prepare a directors’ remuneration report that discusses their remuneration
policies and practices, provide a copy of the report to shareholders, and comply with other requirements such as
engaging auditors to audit a portion of the remuneration report.

Risk Analysis
I. Using Financial Statement Information
A. Financial analysts use various techniques when analyzing financial statement information.
1. Comparative financial statements—compare year-to-year financial position, results of operations, and cash
flows.
2. Horizontal analysis—percentage change in financial statement item since a base year.
3. Vertical analysis—financial statement item expressed as a percentage of a total amount.
4. Ratio analysis—convert financial statement items to ratios.
B. The most common way of comparing accounting numbers to evaluate the performance and risk of a firm is ratio
analysis.
II. Liquidity Ratios
A. Liquidity refers to the ability of a company to convert its assets to cash to pay its current obligations.
B. Working capital, the difference between current assets and current liabilities, is a popular measure of a company's
ability to satisfy its short-term obligations.
C. The current ratio, calculated by dividing current assets by current liabilities, expresses working capital as a ratio
that allows for interfirm comparisons.
D. The acid-test ratio or quick ratio provides a more stringent indication of a company's ability to pay its current
obligations. The ratio excludes inventories and prepaid expenses from current assets before dividing by current
liabilities.
III. Solvency Ratios
A. Solvency ratios provide some indication of the riskiness of a company with regard to its ability to pay its long-term
debts.
B. The debt to equity ratio indicates the extent of reliance on creditors, rather than owners, in providing resources.
1. The ratio is calculated by dividing total liabilities by total shareholders' equity.
2. The debt to equity ratio indicates the extent of trading on the equity or financial leverage.
 C. The times interest earned ratio indicates the margin of safety provided to creditors. It is calculated by dividing by
interest expense the amount of profit before subtracting interest expense or taxes.
D. Favorable financial leverage means earning a return on borrowed funds that exceeds the cost of borrowing the
funds.

Reporting Segment Information

A. Segment reporting facilitates the financial analysis of diversified companies.
B. Information is reportable for identifiable operating segments.
C. Only segments of a certain size (ten percent or more of total company revenues, assets, or net profit) must be
disclosed. However, a company must account for at least seventy-five percent of consolidated revenue through
segment disclosures.
D. For areas determined to be reportable operating segments, the following disclosures are required:
1. General information about the operating segment.
2. Information about segment revenues, expenses, profit or loss, assets, liabilities, and how the items are
measured.
3. Reconciliation between the total of all the segments’ revenues, profit or loss, assets, liabilities and other
material items and the corresponding amounts for the company as a whole.
E. Under US GAAP, the total liabilities of segments need not be reported.
F. IFRS No. 8 requires an enterprise to report certain geographic information unless it is impracticable to do so.
G. Revenues from major customers must be disclosed.

Part 3. The Statement of Profit or Loss and Other Comprehensive Income

I. Comprehensive Income
A. The purpose of the statement of profit or loss and other comprehensive income is to report a company’s financial
performance, that is, its net profit or loss and other comprehensive income, during a particular reporting period.
B. Comprehensive income is the total change in equity (revenues, expenses, gains, and losses, and other
comprehensive income) for a reporting period other than from transactions with owners.
C. Comprehensive income = Net profit or loss + Other comprehensive income.
D. The information in the statement of profit or loss and other comprehensive income can be presented either (1) in
a single, continuous statement of profit or loss and other comprehensive income or (2) in two separate, but
consecutive statements, a statement of profit or loss and a statement of comprehensive income.

E. Both IFRS and US GAAP allow companies to report comprehensive income in either a single statement of profit or
loss and other comprehensive income or in two separate statements.
II. Profit From Continuing Operations
A. Profit from continuing operations includes the revenues, expenses, gains, and losses from operations that will
probably continue in future periods.
1. A distinction is often made between operating and nonoperating profit. Operating profit relates to the
company’s primary revenue-generating activities whereas nonoperating profit relates to the company’s
peripheral or incidental activities.
2. Income tax expense is always shown as a separate line in the statement of profit or loss.
B. IAS No. 1 allows companies to use either the “nature of expense” method or the “function of expense” method to
classify their expenses on the face of the statement of profit or loss or in the disclosure notes.
1. A statement of profit or loss that uses the nature of expense method classifies expenses by their nature.
2. A statement of profit or loss that uses the function of expense method classifies expenses by their function
within the company.
C. There are more similarities than differences between statements of profit or loss prepared according to IFRS and
those prepared applying US GAAP.
1. IFRS requires certain minimum information to be reported on the face of the statement of profit or loss while
US GAAP has no minimum requirements.
 2. IFRS allows expenses to be classified either by nature or by function while the Securities and Exchange
Commission requires US listed companies to classify expenses only by function.
III. Earnings Quality
A. Earnings quality refers to the ability of reported earnings (profit) to predict a company’s future earnings.
1. To enhance predictive value, analysts try to separate a company’s temporary earnings effects from its
permanent earnings.
2. Many believe that corporate earnings management practices reduce the quality of earnings. Two major
methods used by managers to manipulate income are (1) income shifting and (2) classification shifting in the
statement of profit or loss.
B. Not all items included in operating profit should be considered indicative of a company’s permanent earnings (T4-
5).
1. Restructuring costs include costs associated with shutdown or relocation of facilities or downsizing of
operations. IFRS requires these costs to be expensed in the period(s) incurred.
2. Asset impairment losses, goodwill impairment, and inventory write-down charges are other operating
expenses that call into question the issue of earnings quality.
3. Earnings quality is affected by revenue issues as well.
C. Some nonoperating items have generated considerable discussion with respect to earnings quality, notably gains
and losses generated from the sale of investments.
D. Many companies voluntarily announce pro forma earnings (also known as non-GAAP earnings in the United
States) when they report annual or quarterly earnings. Pro forma earnings exclude certain expenses and
sometimes certain revenues. Pro forma earnings are controversial because determining which expenses to
exclude is at the discretion of management.
IV. Discontinued Operations
A. Discontinued operations involve the disposal or planned disposal of a component of an entity.
1. Discontinued operations must be reported separately, below profit from continuing operations.
2. The objective is to report all of the income effects of a discontinued operation separately. That is why we
include the income tax effect in this separate presentation rather than report it as part of income tax expense
related to continuing operations. The process of associating income tax effects with the statement of profit or
loss components that create those effects is referred to as intra-period tax allocation.
B. What constitutes a discontinued operation?
1. IFRS No. 5 defines a discontinued operation as a discontinued component of an entity and a component of an
entity as a portion of the cash flows and operations of the company that can be segregated from the rest of the
entity for operating and financial reporting purposes.
C. Reporting discontinued operations
1. When the component has been sold, the income effects of a discontinued operation include (1) the operating
profit or loss of the component from the beginning of the reporting period to the disposal date and (2) the gain
or loss on disposal of the component’s assets.
2. When the component is considered held for sale, the income effects of a discontinued operation include (1)
the operating profit or loss of the component from the beginning of the reporting period to the end of the
reporting period and (2) an impairment loss if the carrying amount (book value) of the assets of the component
is more than its fair value minus cost to sell.
3. The assets and liabilities of a component considered held for sale are reported separately in the statement of
financial position at the lower of their carrying amount (book value) or fair value minus cost to sell.
V. Accounting Changes
A. Accounting changes fall into one of two categories: (1) a change in accounting policy or (2) a change in accounting
estimate.
B. Most voluntary changes in accounting policies are accounted for retrospectively by revising previous years'
financial statements.
C. Sometimes the IASB requires (mandates) a change in accounting policy. These changes in accounting policies
potentially hamper the ability of external users to compare financial information among reporting periods
because information lacks consistency. The changes are accounted for in various ways:
 1. Retrospective approach. The new standard is applied to all periods presented in the financial statements as if
the new accounting policy had been used in those prior periods.
2. Modified retrospective approach. The new standard is applied to the adoption period only, and prior period
financial statements are not restated.
3. Prospective approach. No modification is made to prior period financial statements. Instead, the change is
simply implemented in the current period and all future periods.
D. A change in depreciation or amortization method is considered to be a change in accounting estimate. These
changes are accounted for prospectively, exactly as we would account for any other changes in estimates.
E. A change in accounting estimate is reflected in the financial statements of the current period and future periods.
VI. Correction of Accounting Errors
A. Errors discovered in the same year they are made are simply corrected by a journal entry.
B. Treatment of errors discovered in a year subsequent to the year the error is made depends on whether the error
is material.
1. If the error is not material, it is simply corrected in the year discovered.
2. If the error is material, the correction is considered a prior period adjustment, which requires an addition to or
reduction in beginning retained earnings and a restatement of previous years' financial statements.
VII. Earnings per Share
A. Earnings per share (EPS) is the amount of income reported during a period for each ordinary share outstanding.
B. All corporations whose shares are publicly traded must disclose EPS.
C. Basic EPS is calculated as net profit (less any dividends to preference shareholders) divided by the weighted-
average number of ordinary shares outstanding for the year.
D. Diluted EPS accounts for the dilution effect (reduction) in EPS for the potential increase in ordinary shares
outstanding because the company has other instruments that could be converted into ordinary shares or the
company has share options outstanding that could be exercised.
E. The EPS for (a) profit from continuing operations, (b) discontinued operations, and (3) net profit must be
disclosed.

Part B: Profitability Analysis

I. Activity Ratios
A. Activity ratios measure a company's efficiency in managing its assets.
B. The asset turnover ratio measures a company's efficiency in using assets to generate revenue and is calculated by
dividing a company's net sales or revenues by the average total assets available for use during the period.
C. The receivables turnover ratio offers an indication of how quickly a company is able to collect its accounts
receivable.
1. The ratio is calculated by dividing a period's net credit sales by the average net accounts receivable.
2. An extension of this ratio is the average collection period, which is computed by dividing 365 days by the
receivables turnover ratio.
D. The inventory turnover ratio measures a company's efficiency in managing its investment in inventory.
1. The ratio is calculated by dividing the period's cost of goods sold by the average inventory balance.
2. An extension of this ratio is the average days in inventory, which is computed by dividing 365 days by the
inventory turnover ratio.
II. Profitability Ratios
A. Profitability ratios assist in evaluating various aspects of a company's profit-making activities.
B. The profit margin on sales measures the amount of net profit achieved per sales dollar and is computed by
dividing net profit by net sales.
C. The return on assets (ROA) indicates a company's overall profitability.
1. It is calculated by dividing net profit by average total assets.
2. The return on assets can also be computed by multiplying the profit margin on sales by the asset turnover.
D. The return on shareholders' equity measures the return to suppliers of equity capital. It is calculated by dividing
net profit by average shareholders' equity.
 E. The DuPont framework helps identify how profitability, activity, and financial leverage trade off to determine
return to shareholders.

Interim Reporting
A. Interim reports are issued for periods of less than a year, typically as quarterly or semiannual financial statements.
B. With only a few exceptions, the same accounting policies applicable to annual reporting are used for interim
reporting.
C. Complete financial statements are not required for interim reporting, but certain disclosures are required for
significant events and transactions such as the following:
1. Recognition and reversal of impairment loss and write-downs.
2. Purchase and disposal of property, plant, and equipment.
3. Litigation settlements.
4. Changes in accounting policies, accounting estimates, and correction of errors.
5. Related party transactions.
6. Changes in the classification of financial assets.
7. Changes in contingent liabilities or contingent assets.
8. Seasonal revenues, costs, and expenses.
9. Issuance of debt and equity securities.
10.Dividends paid.
11.Changes in corporate structure such as business combinations, gain or loss of control of investments,
restructurings, and discontinued operations.
12.Unusual or infrequent items.

Part 4: The Content and Value of the Statement of Cash Flows

I. Overview of Cash Flow Information
A. The purpose of the statement of cash flows is to provide information about cash receipts and cash disbursements
that occurred during a period.
B. A statement of cash flows is presented for each period for which a statement of profit or loss and other
comprehensive income is reported.
C. Investors and creditors analyze the prospects of receiving a cash return from their dealings with a firm.
1. Cash flows to investors and creditors depend on the company generating cash flows to itself.
2. Decision makers rely heavily on the information reported in periodic financial statements to project a
company’s cash-generating ability.
3. Some important questions are not easily answered from the information the statement of financial position
and statement of profit or loss provide.
II. Cash Inflows and Outflows
A. Cash continuously flows into and out of an active business.
B. The statement of cash flows presents information about cash flows that the statement of financial position and
statement of profit or loss either do not provide or provide only indirectly.
C. The statement of cash flows fills an information gap left by the other statements, providing a list of the cash
inflows and outflows that occurred during the reporting period. The basic structure and composition of the
statement of cash flows is overviewed in Illustration 4–2.
III. Usefulness of the Statement of Cash Flows
A. To enhance the informational value of the statement of cash flows, the cash flows are classified according to the
source or nature of the activities that bring about the cash flows (operating, investing, or financing activities).
B. Investors and creditors’ decisions about contributing capital to a company depend on their evaluations of the
amount, timing, and uncertainty of the company’s future cash flows.
C. Information about cash flows from operating and other activities can provide information helpful in assessing
future profitability, liquidity, and long-term solvency.
 D. Many companies suffered bankruptcy because they were unable to generate sufficient cash to satisfy their
obligations. The survival and success of every business depends on its ability to create or otherwise attain cash.
IV. Cash, Cash Equivalents, and Restricted Cash
A. The statement of cash flows does not differentiate between amounts held as cash and amounts held in cash
equivalent investments or as restricted cash.
B. Cash equivalents are short-term, highly liquid investments that can readily be converted to cash with little risk of
loss.
1. Examples are money market funds, treasury bills, and commercial paper.
2. These investments must have a maturity date not longer than three months from the date of purchase.
Companies establish a policy regarding which short-term, highly liquid investments they classify as cash
equivalents and disclose that policy in the notes.
C. Transactions that involve merely transfers from cash to cash equivalents (such as the purchase of a three-month
treasury bill) are not reported on the statement of cash flows because the total of cash and cash equivalents is not
altered by such transactions.
V. Cash Flows From Operating Activities
A. Cash flows from operating activities are cash inflows and outflows related to the transactions entering into the
determination of net profit or loss in the statement of profit or loss.
B. The classification includes the elements of net profit, but reported on a cash basis, such as:
1. cash received from customers rather than sales and service revenue;
2. cash revenue received rather than investment revenue;
3. cash paid to suppliers rather than cost of goods sold;
4. cash paid to employees rather than salaries expense; and
5. cash paid to the government rather than income tax expense.
C. Non-cash items reported on the statement of profit or loss but not reported on the statement of cash flows
include:
1. gain on sale of assets,
2. loss on sale of assets, and
3. depreciation and amortization.
VI. Cash Flows From Investing Activities
A. Cash flows from investing activities are related to the acquisition and disposition of long-term assets used in the
business and non-operating investment assets.
B. The classification includes the acquisition of:
1. property, plant, and equipment and other long-lived productive assets used in the business (except
inventories);
2. investments in securities (except cash equivalents and trading securities); and
3. non-trade receivables.
C. The classification also includes any cash receipts from their disposition, such as:
1. sale of property, plant, and equipment and other long-lived assets used in the business;
2. sale of investments in securities (except cash equivalents and trading securities); and
3. collection of non-trade receivables.
D. Under IFRS, the collection of cash interest from debt investments and cash dividends from equity investments can
be classified as cash flows from operating or investing activities.
VII. Cash Flows From Financing Activities
A. Cash flows from financing activities relate to a company’s external financing transactions with investors and
creditors (excluding trade creditors).
B. The classification includes:
1. issuance of shares and
2. issuance of debt securities such as notes, loans, mortgages, and bonds.
C. The classification also includes subsequent transactions related to these, such as:
1. repurchase of ordinary or preference shares (to retire the shares or as treasury shares),
2. repayment of debt,
 3. payment of cash dividends to shareholders, and
4. payment of cash interest to bondholders or debtholders.
D. Under IFRS, the payment of interest and dividends can be classified as cash flows from operating activities or
financing activities:
VIII. Noncash Investing and Financing Activities
A. Noncash investing and financing activities, such as acquiring equipment (an investing activity) by issuing a long-
term note payable (a financing activity) must also be disclosed.
B. Examples of transactions that do not increase or decrease cash, but which result in significant investing and
financing activities are:
1. acquiring an asset by incurring a debt payable to the seller;
2. acquiring use of an asset by entering into a lease agreement;
3. converting debt into ordinary shares or other equity securities; and
4. exchanging noncash assets or liabilities for other noncash assets or liabilities.
C. Noncash transactions that do not affect a company's assets or liabilities, such as the distribution of bonus issues of
shares, are not considered investing or financing activities and are not reported.
D. Noncash investing and financing activities are disclosed in the notes to the financial statements.
E. Both IFRS and US GAAP require a statement of cash flows that classifies cash flows into operating, investing, or
financing activities.
1. US GAAP designates interest payments, interest received, and dividends received as operating cash flows and
dividend payments as financing cash flows.
2. IFRS allows more flexibility and allows companies to report interest and dividends received as operating or
investing cash flows, and interest and dividends paid as operating or financing cash flows, provided that they
are classified consistently from period to period.
3. Interest received and dividends received are normally classified as investing activities, while interest payments
and dividend payments are usually reported as financing activities.

Part B: Preparing the SCF: Direct Method of Reporting Cash Flows From Operating Activities
I. Using a Spreadsheet
A. A spreadsheet offers a systematic method of preparing a statement of cash flows.
1. It allows us to analyze available data to ensure that all operating, investing, and financing activities are
detected.
2. We use it to record spreadsheet entries that explain account balance changes and simultaneously identify and
classify the activities reported on the statement of cash flows.
3. It relies on the fact that, for cash to increase or decrease, there must be a corresponding change in a non-cash
account. Thus, if we can identify the events and transactions that caused the change in each non-cash account
during the year, we will have identified all the operating, investing, and financing activities that occurred.
B. Procedure:
1. Enter the beginning and ending balances of each account by transferring the comparative statements of
financial position and statement of profit or loss to a blank spreadsheet.
2. Following the statements of financial position and statement of profit or loss, we allocate space on the
spreadsheet for the statement of cash flows.
3. Enter spreadsheet entries that duplicate the actual journal entries used to record the transactions as they
occurred during the year.
4. When a transaction being entered on the spreadsheet includes an operating, investing, or financing activity,
enter that portion of the entry under the corresponding heading of the statement of cash flows section of the
spreadsheet.
5. Since there can be no operating, investing, or financing activity without a corresponding change in one or more
of the non-cash accounts, once all non-cash account balance changes are “explained” we should feel confident
that we have identified all of the activities that should be reported on the statement of cash flows.
6. To check the accuracy of the analysis, compare the change in the balance of the cash account with the net
change in cash flows produced by the activities listed in the statement of cash flows section of the
spreadsheet.
 7. The spreadsheet is now complete. The statement of cash flows can now be prepared directly from the
spreadsheet simply by presenting the items included in the statement of cash flows section of the spreadsheet
in the appropriate format of the statement.

Part C: Preparing the SCF: Indirect Method of Reporting Cash Flows From Operating
Activities
I. Getting There Through the Back Door
A. Either the direct or the indirect method can be used to calculate and present the net cash increase or decrease
from operating activities.
B. Unlike the direct method, which directly lists cash inflows and outflows, the indirect method derives cash flows
indirectly, by starting with reported net profit or loss and "working backwards" to convert that amount to a cash
basis.
C. The indirect method yields the same net cash flows from operating activities as does the direct method. The
indirect method simply reverses the differences between the accrual-based statement of profit or loss and "cash
flows from operating activities."
II. Decision Makers’ Perspective—Cash Flow Ratios
A. Some analysts supplement their analysis with cash flow ratios.
1. Some cash flow ratios are derived by simply substituting “Cash flow from operations” in place of net profit in
many ratios, not to replace those ratios, but to complement them.
2. Cash flow ratios offer insight in the evaluation of a company’s profitability and financial strength.