1 click to edit master title style 1 1 1 16 statement of cash flows

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Statement Statement of Cash of Cash FlowsFlows

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1. Summarize the types of cash flow activities reported in the statement of cash flows.

2. Prepare a statement of cash flows, using the indirect method.

3. Prepare a statement of cash flows, using the direct method.

After studying this chapter, you should be able to:

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Summarize the types of cash flow activities

reported in the statement of cash flows.

Objective 1Objective 1Objective 1Objective 1

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The statement of cash flows reports a firm’s major cash inflows and outflows

for a period. It provides useful information about a firm’s ability to

generate cash from operations, maintain and expand its operating

capacity, meet its financial obligations, and pay dividends.

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Reporting Cash Flows 16-1

The statement of cash flows reports cash flows from three types of activities:

1. Cash flows from operating activities are cash flows from transactions that affect net income.

2. Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets.

3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business.

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Statement of Cash Flows—NetSolutions

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(payments for treasury stock, dividends, and redemption of debt securities)

Financing Financing

(payments for expenses)

Operating Operating

Sources (increases) of Cash Uses (decreases) of Cash

(receipts from sales of noncurrent assets)

Investing Investing

(receipts from issuing equity and debt

securities)

Financing Financing

(payments for acquiring noncurrent

assets)

Investing Investing

(receipts from revenues)

Operating Operating

Exhibit 2 Cash Flows 16-1

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Cash Flows from Operating Activities 16-1

The direct method reports the sources of operating cash and

the uses of operating cash.8

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16-1

The indirect method reports the operating cash flows by beginning with net income and

adjusting it for revenues and expenses that do not involve the receipt or payment of cash.

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Cash inflows from operating activities normally arise when cash is received from customers.

Cash outflows from operating activities normally arise when cash is paid to suppliers for merchandise, supplies, services and to employees for salaries and wages.

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A primary advantage of the direct method is that it reports the sources and uses of operating cash flows in

the statement of cash flow.

A primary disadvantage of the direct method is that the necessary data

may not be readily available and may be costly to gather.

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16-1

A primary advantage of the indirect method is that it focuses on the

differences between net income and cash flows from operations.

Because the data are readily available, another advantage of the indirect

method is that it is normally less costly to use than the direct method.

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Cash Flows from Operations: Direct and Indirect Methods—NetSolutions

16-1

same amount

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Cash Flows from Investing Activities 16-1

Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.

Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.

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Cash Flows from Financing Activities 16-1

Cash inflows from financing activities normally arise from issuing debt or equity securities.

Cash outflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock.

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Noncash Investing and Financing Activities

16-1

Noncash investing and financing activities are transactions that do not

involve cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of

the statement of cash flows.

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16-1

I M P O R T A N T

The financial statements, including the statement of

cash flows, should not report cash flow per share.

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Example Exercise 16-1

16-1

For each of the following, identify whether it would be disclosed as an operating, financing, or investing activity on the statement of cash flows under the indirect method.

a. Purchase patent

b. Pay cash dividend

c. Disposal of equipment

d. Net income

e. Purchase treasury stock

f. Depreciation expense

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19For Practice: PE 16-1A, PE 16-1B

Follow My Example 16-1

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16-1

a. Investing

b. Financing

c. Investing

d. Operating

e. Financing

f. Operating

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Prepare a statement of cash flows, using the

indirect method.


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An efficient approach to preparing the statement of cash flows is to analyze the

changes in the noncash balance sheet accounts. The logic of this approach is that a

change in any balance sheet account (including Cash) can be analyzed in terms of changes in the other balance sheet accounts.

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The analysis of Retained Earnings provides a good starting point for determining the cash flows from

operating activities, which is the first section of the statement of cash flows.

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Comparative Balance Sheet

(Continued)

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Comparative Balance Sheet

(Concluded)

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Retained Earnings

The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year.

ACCOUNT Retained Earnings ACCOUNT NO. 32

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 202,300.00Dec. 31 Net income 108,000.00 310,300.00

31 Cash dividends 28,000.00 282,300.00

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ACCOUNT Retained Earnings ACCOUNT NO. 32

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 202,300.00Dec. 31 Net income 108,000.00 310,300.00

31 Cash dividends 28,000.00 282,300.00

The net income of $108,000 is entered on the statement (or working papers).

To statementTo statementTo statementTo statement

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Operating Activities— Rundell Inc.

Cash flows from operating activities:Net income $108,000Adjustments to reconcile net income

to net cash flow from operating activities:

This phrase is added to indicate This phrase is added to indicate that accrual basis net income is that accrual basis net income is being adjusted to arrive at cash being adjusted to arrive at cash

flows from operations.flows from operations.

This phrase is added to indicate This phrase is added to indicate that accrual basis net income is that accrual basis net income is being adjusted to arrive at cash being adjusted to arrive at cash

flows from operations.flows from operations.

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Next, we need to determine depreciation expense for the year. If it

isn’t given in the income statement, sometimes it can be found by

analyzing the various accumulated depreciation accounts.

16-2

Depreciation

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ACCOUNT Accumulated Depreciation—Building ACCT. NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 58,300.00Dec. 31 Depr. for year 7,000.00 65,300.00

to statementto statementto statementto statement

The comparative balance sheet (Exhibit 4: Slides 23 and 24) indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry.

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The offsetting $7,000 debit is to an expense for depreciation. The

effect on the income statement was to reduced net income; however, this expense did not require an outflow of cash. Therefore, the

$7,000 is added back to net income in determining cash flows from

operating activities.

16-2

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Amortization is treated in the same manner as

depreciation.

16-2Cash flows from operating activities:

Net income $108,000Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation Depreciation 7,000 7,000

Operating Activities—Rundell Inc.

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Gain on Sale of Land

The ledger or income statement of Rundell Inc. indicates that the sale of land resulted in a gain of $12,000. This gain increased

net income by $12,000, yet cash flows was provided by an investing activity (selling land) rather than an operating activity, so

the gain is deducted from net income on the statement of cash flows.

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Operating Activities—Rundell Inc.

Cash flows from operating activities:Net income $108,000Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation 7,000Gain on sale of landGain on sale of land (12,000)(12,000)

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Omni Corporation’s accumulated depreciation increased by $12,000, while patents decreased by $3,400 between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from sale of land. Reconcile a net income of $50,000 to net cash flow from operating activities.

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Net income $50,000Adjustments to reconcile net income from operating activities:

Depreciation 12,000Amortization 3,400Gain on sale of land (4,100)

Net cash flow from operating activities $61,300

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Next, select current assets and current liabilities that impact cash flows and determine their increases and decreases. Exhibit 5 in the next

slide my prove to be helpful in determining how to treat increases and decreases in noncash current

operating assets and current operating liabilities.

16-2

Changes in Current Operating Assets and Liabilities

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Adjustments to Net Income (Loss) Using the Indirect Method

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Changes in Current AccountsChanges in Current Accounts

Accounts

Accounts receivable (net) $ 74,000 $ 65,000

Inventories 172,000 180,000

Accounts payable (mdse.) 43,500 46,700

Accrued expenses payable 26,500 24,300

Income taxes payable 7,900 8,400

9,000

8,000*

3,200*

2,200

500*

2008 2007

December 31 Increase

Decrease*

16-2

Note that Cash and Dividends Payable are not included in this analysis.

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Cash flows from operating activities:Net income $108,000Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation 7,000Gain on sale of land (12,000)

Changes in current operating assets Changes in current operating assets and liabilities:and liabilities:

Increase in accounts receivableIncrease in accounts receivable (9,000)(9,000)Decrease in inventoryDecrease in inventory 8,0008,000Decrease in accounts payableDecrease in accounts payable (3,200)(3,200)Increase in accrued expensesIncrease in accrued expenses 2,2002,200Decrease in income taxes payableDecrease in income taxes payable (500)(500)

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Operating Activities—Indirect Method

39You will notice that increases actually decrease cash flows from operating activities, and decreases do just the opposite.

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Statement of Cash Flows—Indirect Method for Rundell Inc. (Operating Activities Section)

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Same information as Slide 39, only in final form.

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Victor Corporation’s comparative balance sheet for current assets and current liabilities was as follows:

Dec. 31, 2009 Dec. 31, 2008

Accounts receivable $ 6,500 $ 4,900Inventory 12,300 15,000Accounts payable 4,800 5,200Dividends payable 5,000 4,000

Adjust net income of $70,000 for changes in operating assets and liabilities.

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Net income $70,000Adjustments to reconcile net income to net cash from from operating activities:

Increase in accounts receivable (1,600)Decrease in inventory 2,700Decrease in accounts payable (400)


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Omicron, Inc. reported the following data:

Prepare the cash flow for operating activities section of the statement of cash flows using the indirect method.

Net income $120,000Depreciation expense 12,000Loss on disposal of equipment 15,000Increase in Accounts receivable 5,000Decrease in Accounts payable (2,000)

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Follow My Example 16-416-2

Cash flows from operating activities:Net income $120,000 Adjustments

to reconcile net income to net cash flow from operating activities:

Depreciation 12,000Loss from disposal of equipment 15,000Changes in current operating assets and liabilities:

Increase in accounts receivable (5,000)Decrease in accounts payable (2,000)


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Cash Flows Used for Payment of Dividends

ACCOUNT Dividends Payable ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 10,000

10 Cash paid 10,000 —June 20 Dividends declared 14,000 14,000July 10 Cash paid 14,000 —Dec. 20 Dividends declared 14,000 14,000

Note that while $28,000 in dividends were declared, only $24,000 were paid during the year.

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Because paying of dividends affects equity and is an outflow of cash, it is a

negative $24,000 cash flows from financing activities

transaction.

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Common Stock

Common Stock increased by $8,000.

ACCOUNT Common Stock ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 16,000Nov. 1 4,000 shares issued/cash 8,000 24,000

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ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 80,000Nov. 1 4,000 shares issued/cash 40,000 120,000

Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,000.

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Issuing common stock affects equity; therefore, we have a

positive $48,000 cash flows from financing activities item.

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Bonds Payable

Bonds Payable decreased by $50,000.

ACCOUNT Bonds Payable ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 150,000June 30 Retired by payment of

cash at face amount 50,000 100,000

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Retiring bonds is a cash outflow reported as a negative item

under cash flows from financing activities.

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Building

ACCOUNT Building ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 200,000Dec. 27 Purchased for cash 60,000 260,000

By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash.

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Purchasing a building involves a noncurrent asset, so this is a

negative cash flows from investing activity.

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Land

ACCOUNT Land ACCOUNT NO.

Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 125,000June 8 Sold for $72,000 cash 60,000 65,000Oct. 12 Purchased for $15,000

cash 15,000 80,000

The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase.

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The first transaction, the sale of land, is classified as a positive

cash flows from investing activity because land is a noncash asset.

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The $12,000 gain was recorded earlier on Slide 34

as an operating activity. The purchase of land also is an

investing activity.

Click the button to view Slide 34. To return to

this slide, type “56” and press the “Enter” key.

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The second transaction is the purchase of land for cash of $15,000. This transaction is

reported as an outflow of cash in the cash flows from investing activities section.

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Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement)

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Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement)

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The ending balance in the Cash account should match this amount.

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Alpha Corporation purchased land for $125,000. Later in the year the company sold land with a book value of $165,000 for $200,000. How are the effects of these transactions are reported on the statement of cash flows?

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The gain on sale of land is deducted from net income as shown below:

Gain on sale of land

$(35,000)

Cash received for sale of land $200,000Cash paid for purchase of land (125,000)

The purchase and sale of land is reported as part of cash inflow form investing activities as shown below:

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Prepare a statement of cash flows, using the

direct method.


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The final amount for cash flows from operating

activities will be the same whether the direct or

indirect approach is used. The methods differ in

how the data are obtained, analyzed, and reported.

The Direct Method 16-3

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Exhibit 8 Data for Direct Method 16-3

Rundell Inc.Schedule of Changes in Current Accounts

December 31 Accounts 2008 2007 Decrease*

Increase

Cash $ 97,500 $ 26,000 $71,500Accounts receivable (net) 74,000 65,000 9,000Inventories 172,000 180,000 8,000*Accounts payable (merchandise creditors) 43,500 46,700 3,200*Accrued expenses payable (operating expenses) 26,500 24,300 2,200Income taxes payable 7,900 8,400 500*Dividends payable 14,000 10,000 4,000

(Continued)

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Sales $1,180,000

Cost of merchandise sold 790,000

Gross profit $ 390,000Operating expenses:

Depreciation expense $ 7,000 Other operating expenses 196,000

Total operating expenses 203,000Income from operations $ 187,000Other income:

Gain on sale of land $ 12,000

Other expense:Interest expense 8,000 4,000

Income before income tax $ 191,000Income tax 83,000

Net income $ 108,000

Rundell Inc.Income Statement

For the Year Ended December 31, 2008

(Concluded)

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Cash Received from Customers 16-3

The $1,180,000 of sales for Rundell Inc. is reported using

the accrual method. An adjustment is necessary to

convert the sales reported on the income statement to the

cash method.

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Sales $1,180,000











ChangesCash receivedfrom customers

Sales $1,180,000

Cash received from customers $1,171,000

Increase in accounts rec. (9,000)

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Sales $1,180,000











ChangesCash receivedfrom customers

Sales $1,180,000

Increase in accounts rec. (9,000)

Cash received from customers $1,171,000

CASH BASIS

$1,171,000

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16-3

Sales reported on the income statement were $350,000. The accounts receivable balance declined $8,000 over the year. Determine the amount of cash received from customers.

For Practice: PE 16-6A, PE 16-6B


Sales $350,000Add decrease in accounts receivable 8,000Cash received from customer $358,000

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Cash Payments for Merchandise 16-3

Sales $1,180,000











CASH BASIS

$1,171,000

Cash payments formerchandise Changes

Cost of merchandise sold $790,000

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Sales $1,180,000











CASH BASIS

$1,171,000

Cost of merchandise sold

ChangesCash payments for

merchandise

Decrease in inventories (8,000)Decrease in accounts payable 3,200Cash payments for

merchandise $785,200

$790,000

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

Cost of merchandise sold

ChangesCash payments for

merchandise

Decrease in inventories (8,000)Decrease in accounts payable 3,200Cash payments for

merchandise $785,200

$790,000

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16-3

Cost of merchandise sold reported on the income statement was $145,000. The accounts payable balance increased $4,000, and the inventory balance increased by $9,000 over the year. Determine the amount of cash paid for merchandise.

For Practice: PE 16-7A, PE 16-7B


Cost of merchandise sold $145,000Add increase in inventories 9,000Deduct increase in accounts payable (4,000)Cash payments for merchandise $150,000

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Cash Payments for Operating Expenses 16-3

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

0

There is no cash flow for depreciation expense.

There is no cash flow for depreciation expense.

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

0

Changes

Operating expenses (other thandepreciation)

Changes

Cash payments for operating expenses

(193,800)

$196,000Increase in accrued expenses (2,200)Cash payments for operating

expenses $193,800

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

0(193,800)

0


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To avoid confusion, page numbers for the remaining slides are centered on

the slides.

The gain on sale of land of $12,000 is included in the proceeds from the sale

of land, which is reported as part of cash flows from investing activities.

The gain on sale of land of $12,000 is included in the proceeds from the sale

of land, which is reported as part of cash flows from investing activities.

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

0(193,800)

0


Interest expense

ChangesCash paid forinterest expense

8,000

+/- decrease/increase in payable 0

Cash payments for interest $8,000

(8,000)

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

0(193,800)

0

Cash Payments for Income Taxes

(8,000)

Income tax expense

ChangesCash payments for income taxes

$83,000Add decrease in income

taxes payable 500

Cash payments for income tax $83,500

(83,500)79

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Sales $1,180,000











CASH BASIS

$1,171,000(785,200)

0(193,800)

0

Cash Payments for Income Taxes

(8,000)

(83,500)

$ 100,50080

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16-3

Statement of Cash Flows—Direct Method (Operating Activities Section)

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Statement of Cash Flows—Direct Method (Reconciliation)

A reconciliation is required when the direct method is used.

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Financial Analysis and Interpretation

Free cash flow is a measure of operating cash flow available for

corporate purposes after providing sufficient fixed asset additions to

maintain current productive capacity and dividends.

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Cash flow from operations

Less: Investments in fixed assets to maintain current production

Free cash flow

16-3

Free Cash Flow

Positive free cash flow is considered favorable. A company that has free cash flow is able to

fund internal growth, retire debt, pay dividends, and enjoy financial flexibility.

1 click to edit master title style 1 1 1 16 statement of cash flows

Documents

operating cash flows

reporting cash flows

cash outflows

payment of cash

sources of operating

uses of operating cash

decreases of cash receipts

types of cash flow activities