Identify and describe the three categories of cash flows reported on the statement of cash flows. What problems have been noted related to this classification system?

Question

What will be an ideal response?

Answer 1

ANSWER:
The cash flow statement subclassifies cash receipts and payments into operating, financing, and investing activities. Operating activities include all transactions that are not investing and financing activities. These include cash received from customers and cash paid to suppliers and employees. The operating activities section also includes dividends received and interest received and paid. Income taxes paid, insurance proceeds received, and cash paid to settle lawsuits are also included in operating activities.

Cash flows from investing activities include transactions involving lending money, collecting on the loans, acquiring and selling investments, and acquiring and selling plant assets. Cash flows from financing activities include transactions involving resources obtained from owners, as well as obtaining funds from creditors and repaying the amounts borrowed. This includes principal payments under capital lease obligations, proceeds from issuance of long-term debt, proceeds from issuance of common stock, and dividends paid.

A problem with this method of classification is that interest and dividend receipts and interest payments are operating inflows and outflows, respectively. According to the finance literature, interest and dividend receipts are investing activities, and interest payments are financing activities. In addition, interest expense, interest revenue, and dividend revenue all appear in the operations section whereas the related balance sheet items (bonds payable, stock investment, and long-term notes receivable) are either financing or investing elements.