Question

The first step in the preparation of the statement of cash flows requires the use of information included in which comparative financial statements?

1) Statements of retained earnings.
2) Balance sheets.
3) Statements of cash flows.
4) Income statements.

Answer 1

The 2) balance sheets show changes in financial status, which help determine cash flows across activities, and the income statement provides necessary adjustments for non-cash items.

Step-by-step explanation:

The first step in the preparation of a statement of cash flows involves analysis of two main financial statements: the balance sheets from two consecutive periods and the current period's income statement. The balance sheets provide information on the changes in assets, liabilities, and equity, which help determine the cash flows from operating, investing, and financing activities. The income statement is used to reconcile net income to the cash provided by operating activities.

The information contained in the balance sheets is critical as it shows the end and start point of a company's financial status over the period, while the income statement contains non-cash charges and credits that need to be adjusted to calculate the cash flow from operations. Comparative balance sheets highlight changes in account balances from one period to the next, which directly impact the cash flow, such as changes in accounts receivable, inventory, accounts payable, and accrued expenses. Therefore, the correct option is 2) Balance sheets.