InstructorSalomien de klerkShow bio
Salomien is a Chartered Accountant (South Africa) and has a degree in Accounting and Auditing. She has worked in public practice for 25 years and was also responsible for training staff and clients.
In this lesson, we will explain how to detect and investigate discrepancies while aligning the statement of cash flow amounts with supporting documentation. We also explain how to adjust a statement of cash flows to correct errors.
Table of Contents
- Workings of the Statement of Cash Flow
- Detect and Investigate Discrepancies
- Correct Errors
- Lesson Summary
The statement of cash flows is one of the fundamental financial statements in which the cash implications of all the transactions an entity entered into in the reporting period are presented. The cash-effects of the transactions are summarized and presented in three sections -- cash provided/used by operating activities, investing activities, and financing activities -- and the total cash flows for all three sections should equal the difference between the beginning and ending cash balance in the balance sheet.
The statement of cash flows can be prepared using either:
- The direct method, which is when the cash flow from operating activities is calculated by listing the sources of operating cash inflows (cash receipts from customers for example) and outflows (like cash payments to suppliers and employees), or
- The indirect method, which is when the cash flow from operating activities is calculated starting with the net income, then adding back all the non-cash-flow items included in the income statement and then considering the changes in working capital accounts.
The statement of cash flows is normally prepared after the income statement and balance sheet are finalized, and some of the information needed to prepare it can be obtained directly from the other financial statements, especially when the indirect method is used to prepare the statement. The increase/decrease in accounts receivable and payable, the change in inventory, and prepaid expenses, for example, are usually evident from the balance sheet and the related notes, and you obviously get the net income as per the income statement from the income statement.
On the other hand, some other items, like the proceeds from the sale of property, plant, and equipment and the cash outflow for assets purchased that was partially funded by stock or bond issues, do not appear on the financial statements or in the notes, and you need to look to supporting documentation for these.
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The first sign that the cash flow statement has errors in it is that it simply is out of balance, meaning that the total of its three sections is not equal to the change in the cash asset. This can be due to:
- Mathematical errors like adding errors or calculating the increase in the various line items incorrectly.
- Errors in logic, meaning that you have, for instance, added an item that should have been deducted and vice versa. It sometimes feels counter-intuitive to treat an increase in, for example, an asset like inventory as a negative. When the cash flow statement does not balance, look again at each line item to verify that you have added the items that are sources of cash (like the increase of a liability) and deducted the items that represent cash outflows (like an increase of an asset).
- Not eliminating all the non-cash-flow transactions that are included in the income statement. If you, for example, do not add back the depreciation of property, plant, and equipment or the gains made on investments, the cash flow statement will not balance.
However, even when the statement of cash flow is in balance, it can still contain errors, and that is why it is important to align each line item with supporting documentation. Some discrepancies and their possible reasons are:
| Discrepancy | Reason |
|---|---|
| Cost of purchases of property, plant, and equipment as per the subsidiary ledger does not agree with the cash flow statement. | The cash flow statement can be wrong, in that you might have used the differences between the beginning and ending at cost accounts, not taking the effect of asset disposals into account. The subsidiary ledger can also be wrong or at least not very helpful because total purchases can include assets purchased through noncash, meaning, for example, issuing bonds or asset-stock swaps. |
| The cash inflow from stock issues is not the same as stock issued in the statement of changes in stockholders' equity. | This is not necessarily an error. The statement of cash flows should only present the cash inflow from stock issues, while the statement of changes in shareholders' equity will include all stock issues. |
| Dividend paid as per the cash flow statement does not agree with dividends declared in the statement of changes in shareholders' equity. | Again, this is maybe not wrong. The statement of cash flows must record the dividends paid in cash in the reporting period, not those declared. |
| The ending cash balance in the cash flow statement does not agree with the balance sheet. | This is an error, as cash and cash equivalents are defined in the same way for the balance sheet and the statement of cash flows. Compare the two amounts to the underlying accounting records to find out which one is correct and then analyze and correct the error in the other statement. |
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To correct an error you have discovered in the same year it was made, you should follow this process:
- Analyze the error to establish the reason it was made.
- Decide what is the correct amount based on the underlying records and where the error should be fixed. It can be that the cash flow statement must be updated, but your investigation can also indicate that the supporting documentation must be updated, for example, to distinguish between cash and noncash asset purchases.
- Correct the error where it was made or update the documentation.
- Align the updated cash flow statement with the updated supporting documentation to verify that the error was appropriately corrected.
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The statement of cash flows is one of the fundamental financial statements in which the cash implications of all the transactions an entity entered into in the reporting period are presented. The first sign that the cash flow statement is wrong is that it is simply out of balance, meaning that the total of its three sections is not equal to the change in the cash asset. This is usually due to mathematical errors or errors in logic.
To correct an error you have discovered in the same year it was made, you should analyze the error, decide what the correct amount is and where the correction was made and where it should be corrected, make the correction, and align the updated cash flow statement with the updated to supporting documentation again to verify that the correction was appropriate.
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