Anthony wrote: "the average investor should be checking out the cash flows statement in general to understand the general trend and solidity of a company. Accrual basis data doesn't give nearly as much foresight into future projections of how a company". As indicated in Anthony's response, the statement of cash flows shows the uses and sources of: cash during for the operating, investing, and financing activities of a company. The balance sheet and income statement are prepared using the accrual basis of accounting.
The statement above regarding the investor's assessment of the general trend and solidity of a company is assuming that all cash transactions are correctly classified as operating, investing or financing activities on the statement of cash flows. Take a look at the ethics case presented in BYP 12-9 that appears in the Broadening Your Perspective section at the end of Chapter 12 in the WileyPLUS Readings or on page 683 in the eBook version. The ethics case provides additional information than presented below, which are the key points of the case.
The board policy requires the statement of cash flows for Templeton Automotive shows that net cash from operating activities exceeds $1 million dollars. However, the net cash from operating activities amounts to $970,000. The president of the company asks Nick, the controller if there is any way to increase the operating cash flows by $30,000 or more.
"Upon close scrutiny of the statement of cash flows, Nick concludes that he can get the operating cash flows above $1 million by reclassifying a $60,000, 2-year note payable listed in the financing activities section as "Proceeds from bank loan--$60,000." He will report the note instead as "Increase in payables--$60,000" and treat it as an adjustment of net income in the operating activities section." (Kimmel, 2013)
Class, how does the misclassification of a financing activity as an operating activity on the statement of cash flows impact the decision making process of an external user as to the financial status of the company?
Reference
Kimmel, P. D. (2013). Financial accounting: Tools for business decision making. Retrieved from University of Phoenix eBook Collection.