CPA Exam: FAR · Financial Reporting
CPA Exam: FAR: General-Purpose Financial Statements Concepts
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Overview
This chapter is about the set of reports a business gives to outside readers such as lenders and investors. A complete set includes a balance sheet, an income statement, a statement of comprehensive income, a statement of changes in equity, a statement of cash flows, and the notes. Each report answers a different question: what the company owns and owes, how it performed, how its owners' stake changed, and where its cash came from and went.
On the balance sheet, assets and liabilities are split into current and noncurrent. An item is current if it will be used up, collected, or paid within one year or one operating cycle, whichever is longer. Comprehensive income adds certain gains and losses that skip net income, called other comprehensive income, such as unrealized gains and losses on available-for-sale debt securities and foreign currency translation adjustments. Companies may show it in one continuous statement or in two statements placed back to back.
The statement of cash flows sorts every cash movement into operating, investing, or financing activities. Under US GAAP, interest paid, interest received, and dividends received are operating, while dividends paid are financing. Operating cash flow can be shown by the direct method or the indirect method, and the indirect method starts from net income and removes noncash items like depreciation. Large noncash deals, such as buying a building by signing a note, are disclosed rather than shown as cash flows.
Key concepts
Current vs. noncurrent
Current assets are expected to be turned into cash, sold, or used up within one year or the operating cycle, whichever is longer. Current liabilities are those expected to be paid in that same period, usually with current assets.
Memory tipAsk: will this be settled within the next year (or a longer operating cycle)? If yes, it is current.
Source: FASB ASC 210 · as of 2026
Other comprehensive income (OCI)
Gains and losses reported outside net income and collected in accumulated other comprehensive income in equity. Examples: unrealized gains and losses on available-for-sale debt securities, foreign currency translation adjustments, certain pension amounts, and the effective part of cash flow hedges.
Memory tipUnrealized gains on equity securities and trading securities go to net income, not OCI.
Source: FASB ASC 220 · as of 2026
Statement of comprehensive income format
Net income and OCI may be shown in one continuous statement, or in two separate but consecutive statements. Either way, total comprehensive income must be shown.
Memory tipShowing OCI only in the statement of changes in equity is not allowed.
Source: FASB ASC 220 · as of 2026
Cash flow classes
Operating covers the day-to-day business. Investing covers buying and selling long-term assets and investments and making loans. Financing covers borrowing and repaying debt, issuing stock, buying back stock, and paying dividends.
Memory tipInterest paid, interest received, and dividends received are operating; dividends paid are financing.
Source: FASB ASC 230 · as of 2026
Indirect method
Operating cash flow is found by starting with net income, adding back noncash expenses like depreciation, removing gains and adding losses on sales of assets, and adjusting for changes in working-capital accounts.
Memory tipAn increase in accounts receivable is subtracted; an increase in accounts payable is added.
Source: FASB ASC 230 · as of 2026
Noncash investing and financing
Significant deals that involve no cash, such as acquiring equipment by issuing a note or converting bonds into stock. They are left out of the cash flow categories and disclosed separately.
Memory tipIf no cash moved, it does not appear in the three sections of the statement.
Source: FASB ASC 230 · as of 2026
Often tested
- A complete set of statements includes notes; the notes are part of the statements, not an extra.
- Current means within one year or the operating cycle, whichever is longer.
- AFS debt unrealized gains and losses go to OCI; equity security changes generally go to net income.
- Dividends paid are financing; interest paid is operating under US GAAP.
- The indirect method adds back depreciation and adjusts for working-capital changes.
Easy to confuse: Direct vs. indirect method
| Item | Direct method | Indirect method |
|---|---|---|
| Starting point | Cash collected from customers and cash paid out by type | Net income |
| Depreciation | Not shown (no cash) | Added back to net income |
| Reconciliation of net income to operating cash flow | Still required | Is the operating section itself |
3 sample questions
Verified practice questions from this unit.
Question 1. Lake Co. reports net income of $50,000. Depreciation expense was $8,000. Accounts receivable increased by $5,000 and accounts payable increased by $3,000. Using the indirect method, what is net cash provided by operating activities?
- ① $60,000
- ② $50,000
- ③ $56,000
- ④ $40,000
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Answer: ③ $56,000
Key point: Indirect method: add noncash items, adjust working capital
Start with net income and remove noncash items and working capital effects.
- Net income: $50,000
- Add depreciation (noncash): +$8,000 → $58,000
- Subtract increase in receivables (sales not yet collected): −$5,000 → $53,000
- Add increase in payables (costs not yet paid): +$3,000 → $56,000
Check: 50,000 + 8,000 − 5,000 + 3,000 = 56,000.
Wrong choices
- $60,000: This reverses the signs of both working capital changes: an increase in receivables lowers cash, and an increase in payables raises it.
- $50,000: This subtracts the increase in payables. A payables increase means cash was not yet paid, so it is added back.
- $40,000: This subtracts depreciation. Depreciation is a noncash expense and is added back to net income.
Question 2. Under US GAAP, how is cash paid for interest on a company's bank loan classified in the statement of cash flows?
- ① Financing activities
- ② Operating activities
- ③ Either operating or financing, as chosen by company policy
- ④ Investing activities
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Answer: ② Operating activities
Key point: US GAAP: interest paid is an operating cash flow
Under US GAAP, interest paid and interest received are both operating cash flows because interest expense and interest income are part of net income. Only the repayment of the loan principal is a financing cash outflow.
Wrong choices
- Financing activities: Repaying loan principal is financing, but interest paid is an operating cash flow under US GAAP.
- Either operating or financing, as chosen by company policy: A policy choice for interest paid is allowed under IFRS, not under US GAAP.
- Investing activities: Investing covers buying and selling long-term assets and investments, not paying interest.
Question 3. Which of the following cash flows is reported as an investing activity in a for-profit company's statement of cash flows?
- ① Cash paid for dividends to shareholders
- ② Cash received from issuing bonds
- ③ Cash paid to buy new equipment
- ④ Cash paid to suppliers for inventory
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Answer: ③ Cash paid to buy new equipment
Key point: Buying/selling long-term assets = investing
Investing activities are cash flows from buying and selling long-term assets (such as equipment, land, and buildings) and investments in other entities, and from making and collecting loans. Buying equipment is a classic investing outflow.
Wrong choices
- Cash paid for dividends to shareholders: Dividends paid are payments to owners, which are financing activities.
- Cash received from issuing bonds: Borrowing money by issuing bonds is a financing activity.
- Cash paid to suppliers for inventory: Buying inventory is part of normal operations, so it is an operating activity.