21-1 intermediate financial accounting earl k. stice james d. stice © 2012 cengage learning...

21-1

Intermediate Financial Accounting

Earl K. Stice James D. Stice

© 2012 Cengage Learning

PowerPoint presented by Douglas Cloud Professor Emeritus of Accounting, Pepperdine University

Statement of Cash Flows Revisited

Chapter 21Chapter 21

18th Edition

21-2

• If we do not have access to detailed cash flow information, the preparation of a statement of cash flows involves analyzing the income statement and comparative balance sheets to determine how a business generated and used cash.

• A company’s cash inflow and outflow can be determined through a careful analysis of each account contained in these statements.

(continued)

Preparing a Statement of Cash Flows in the Absence of Detailed Transaction Data

21-3

Accounts ReceivableAccounts ReceivableAccounts ReceivableAccounts Receivable

To demonstrate two approaches for gathering information for a statement of cash flows when we do not have ready access to detailed cash inflow and outflow information, we will use Western Reserve’s accounts receivable from Exhibit 21-2 (with the adjustments covered).

(continued)


21-4

How do we explain the change in accounts receivable from $70,500 to $67,000?

(continued)


21-5

We see from Item (1) that sales on account totaled $688,800. When sales is credited, the normal debit is to Accounts Receivable. Let’s plug this into the work sheet.

(continued)


21-6(continued)

Accounts Receivable: $70,500 (dr.) + $688,800 ─ ? = $67,000

We solve the equation to find the missing amount, which is $692,300.

Now we can determine the missing amount.


21-7

When accounts receivable is credited, we can assume that cash is debited. Examine entry (2) in Exhibit 21-2. This is how we arrive at the debit to cash when the information is not given.


21-8


A Second ApproachA Second ApproachA Second ApproachA Second Approach

Beginning accounts receivable (initial amount owed to Western Resources) $ 70,500

+ Sales during the year ($688,800 + $65,000) 753,800= Total amount owed to Western Resources

by customers $824,300– Ending accounts receivable (amount not

yet collected) 67,000= Cash collections for goods and services

already provided $757,300+ Increase in unearned sales revenue 7,000Total cash collections for the period $764,300

21-9


Western Resources’ buildings and equipment account increased from $345,000 to $422,000. A notes to the financial statement reveal that a building with a cost of $40,000 and accumulated depreciation of $26,000 was sold during 2013 for $10,000. The worksheet line for building and equipment is shown below.

$345,000 + ? – $40,000 = $422,000

$117,000

21-10

1.Compute how much the cash balance changed during the year.

(continued)

6-Step Process for Preparing a Statement of Cash Flows

21-11

2.Convert the income statement from an accrual-basis to a cash-basis summary of operations.

a) Eliminate expenses that do not involve the outflow of cash.

b) Eliminate gains and losses associated with investing or financing activities.

c) Adjust for changes in the balances of current operating assets and operating liabilities.

(continued)


21-12

3. Analyze the long-term assets to identify the cash flow effects of investing activities. Also examine certain investment securities accounts.

(continued)


21-13

4. Analyze the long-term debt and stockholders’ equity accounts to determine the cash flow effects of any financing transactions. Also examine changes in short-term loan accounts.

(continued)


21-14

5. Make sure that the total net cash flow from operating, investing, and financing activities is equal to the net increase or decrease in cash as computed in step 1. Then prepare a formal statement of cash flows by classifying all cash inflows and outflows according to operating, investing, and financing activities.

(continued)


21-15

6. Prepare supplemental disclosure, including the disclosure of any significant investing or financing transactions that did not involve cash.


21-16

Step 1: Compute how much the cash balance changed during the year

Step 1: Compute how much the cash balance changed during the year

The purpose of the statement of cash flows is to explain how the

decrease in cash occurred.

An Illustration of the 6-Step Process

Beginning Cash Balance $55,000

Ending Cash Balance (50,600)

Decrease in cash $ (4,400)

–

(continued)

21-17

Step 2: Convert the Income Statement from an accrual to a cash-basis summary of operations

Step 2: Convert the Income Statement from an accrual to a cash-basis summary of operations

Depreciation and amortization (adjustments A1 and A2). Add the amount of depreciation and amortization expense back to net income because no cash flow was associated with these expenses in the current period.

Add: Depreciation Expense $20,900 Amortization Expense 5,000

(continued)


21-18

Gains and losses (adjustments B1 and B2). Subtract the amount of gains and add the amount of losses because they are included in the computation of net income. Failure to adjust for them here would result in counting them twice.

Add: Loss on sale of building

$ 4,000Less: Gain on sale of long-term

investment

$(6,500)

(continued)


21-19

Accounts receivable (adjustment C1). The accounts receivable account decreased because customers paid for more than they purchased this year. Thus, Western Resources’ exceeded sales by $3,500, which explains why the accounts receivable account decreased by $3,500.Add: Decrease in Accounts

Receivable

$3,500

(continues)


21-20

Unearned sales revenue (adjustment C2). The unearned sales revenue account increased by $7,000 (from $25,000 to $32,000), representing cash received from customers in 2013 that won’t be reflected in sales and included in the computation of net income until the subsequent year.Add: Increase in Unearned Sales

Revenue

$7,000

(continued)


21-21

Inventory (adjustment C3). The statement of cash flows should reflect the amount of cash paid for inventory during the year, which is not necessarily the same as the cost of inventory sold. Western Resources’ inventory decreased from $76,500 to $75,000 during 2013, indicating that the amount of inventory purchased during 2013 was less than the amount of inventory sold.

Add: Decrease in Inventory

$1,500(continued)


21-22

Accounts payable (adjustment C4). Western Resources paid for more than it bought from its suppliers during the year. The adjustment necessary to reflect this additional cash outflow is to subtract $6,700 in computing cash from operations.

Subtract: Decrease in Accounts

Payable $(6,700)

(continued)


21-23

Prepaid operating expenses (adjustment C5). Prepaid operating expenses increased from $12,000 to $16,500 during 2013. Prepaid expenses are increased when a company pays cash in advance for a service that it will use later.

Subtract: Increase in Prepaid Operating

Expenses

$(4,500)

(continued)


21-24

Restructuring charge (adjustment C6). A restructuring charge is an accounting estimate of the decrease in value of some assets and the creation of future obligations as a result of the decision to restructure part of the business. Western Resources’ restructuring charge of $11,700 is still unpaid as of the end of the year.Add: Increase in Obligation for Employee

Severance

$11,700(continues)


21-25


Interest expense. Because an interest payable account does not exist on the Western Resources’ balance sheet, we can safely assume that all interest expense was paid for in cash. Therefore, there is no need for an adjustment for interest expense.

(continues)

21-26(continued)

Income tax expense (adjustments C7 and C8). The amount of income tax expense reported in the financial statements is not the same as the amount of income tax that is owed to the taxing authorities for the year.

In 2013 the deferred income tax liability for Western Resources increased by $2,700, indicating that some of the $24,000 income tax expense reported won’t actually be payable until some future year.


21-27(continued)

• This means that the income taxes owed for 2013 operations are just $21,300 ($24,000 – $2,700).

• The effect of the increase in the deferred income tax liability is to reduce the amount of cash paid for income taxes this year; this is shown in adjustment C8.

• Western Resources balance sheet indicates that income tax payable decreased by $2,200 during the year (see adjustment C7).


21-28

The Indirect and Direct Methods

• The indirect method begins with net income as reported in the income statement and then details the adjustments needed to arrive at cash flow from operations.

• The direct method involves simply reporting the information contained in the last column of the adjusted work sheet.

(continued)

21-29

Illustration of the 6-Step Process

The long-term investments account was reduced by $96,000 ($106,000 – $10,000) during the year. Since no long-term investments were purchased, the entire $96,000 reduction represents the book value of the long-term investments sold during the year.

(continues)

Long-Term InvestmentsLong-Term InvestmentsLong-Term InvestmentsLong-Term Investments

21-30

Book value of long-term investments sold

$ 96,000Plus: Gain on sales

6,500Cash proceeds

$102,000

By checking the income statement, we determine there was a $6,500 gain on the sale of long-term investments. The cash proceeds of $102,000 can be determined as follows:


21-31

The land account increased by $108,500 ($183,500 – $75,000) during the year. Because there is no indication of land sales during the year, we conclude that the $108,500 represents the price of new land purchased during the year. Supplemental information tells us that payment was a combination of $68,500 cash and common stock valued at $40,000.

(continued)


LandLandLandLand

21-32


Increase in land account

$108,500 Less: Payment with common stock

(40,000) Cash outlay

$ 68,500

Only the $68,500 cash outlay for the land will be shown in the cash flow statement.

21-33

The balance in buildings and equipment account increased by $77,000 ($422,000 – $345,000) during 2013. A building costing $40,000 was sold for $10,000 during the year. With this data we can make the following computation:

(continued)


Building and EquipmentBuilding and EquipmentBuilding and EquipmentBuilding and Equipment

Beginning balance$345,000

Cost of building and equipment sold during the year

(40,000)Ending balance without additional purchases

$305,000

–

=

21-34

A useful way to summarize all purchase and sale information for buildings and equipment is to reconstruct the T-accounts for the buildings and equipment account and the associated accumulated depreciation account.

(continued)


Purchased buildings and equipment for cash of $117,000.

21-35


With this information, we can compute whether the sale of buildings and equipment resulted in a gain or in a loss as follows:Cash proceeds $10,000Book value of items sold ($40,000 – $26,000)

(14,000)Loss on sale of buildings and equipment

$ (4,000)

(continued)

21-36

The patents account began the year with a $40,000 balance and ended with a $35,000 balance. The data indicate that no new patents were purchased during the year. However, amortization was applied to the patent as shown below: Beginning Patents

$40,000– Patent amortization recognized during year

(5,000)+ New patents purchased

??? Ending Patents

$35,000


$40,000(5,000)

0$35,000

21-37

• Although investment securities are now always long-term assets, their purchase and sale are sometimes reported as investing activities.

• Specifically, purchases and sales of available-for-sale and held-to-maturity securities are reported as part of investing activities whereas purchases and sales of trading securities are usually part of operating activities.

• The balance in the available-for-sale securities increased by $2,000.


(continued)

21-38

Cash flows from investing activities: Sold building $ 10,000

Sold long-term investment 102,500 Purchased available-for-sale securities (2,000) Purchased land (68,500) Purchased buildings and equipment (117,000) Net cash used by investing activities $ (75,000)

The Investing Activities section of the statement of cash flows for Western Resources is as follows:

Assumed available-for-sale securities were

purchased

Assumed available-for-sale securities were

purchased


21-39

Step 4: Analyze the long-term debt and stockholders’ equity accounts to identify the cash flow effects of financing transactions

Step 4: Analyze the long-term debt and stockholders’ equity accounts to identify the cash flow effects of financing transactions


Western Resources balance in long-term debt increased by $20,000 ($20,000 – 0) during the year. Accordingly, we infer that the company borrowed an additional $20,000 during 2013, a a cash provided by financing activity.

(continued)

21-40


• The common stock account increased $50,000 ($300,000 – $250,000) during the year. We learned earlier that $40,000 of this increase arose from the exchange of common stock for land.

• The actual cash generated by issuance of new shares during the year is just $10,000. This cash inflow is report as part of cash from financing activities.

(continued)

21-41


• The treasury stock account increased by $3,200 ($59,700 – $56,500) during the year. Thus, the company should report a cash outflow of $3,200 from treasury stock purchases in the Financing Activities section.

• The retained earnings account increases from the recognition of net income, decreases as a result of net losses, and decreases through the payment of dividends.

(continued)

21-42(continued)


• It is possible to infer the amount of dividends declared by identifying the unexplained change in the retained earnings balance. Let’s recreate the retained earnings T-account as follows:

21-43

The increase in Western Resources’ dividends payable account indicates that not all of the $25,100 in dividends declared were paid in cash during the year. We can see this in the following calculation:

Dividends declared $25,100Less: Increase in dividends payable 4,400Cash paid for dividends $20,700

(continued)


21-44

Cash flows from financing activities: Issued common stock $10,000 Borrowed short-term debt 7,500 Borrowed long-term debt 20,000 Paid dividends (20,700) Treasury stock purchases (3,200)

Net cash provided by financing activities $13,600

The following information summarizes the cash flow effects of Western Resources’ financing activities in 2013:


21-45

Step 5: Prepare a formal statement of cash flows

Step 5: Prepare a formal statement of cash flows


(continued)

21-46

Step 6: Prepare supplemental disclosuresStep 6: Prepare supplemental disclosures

1. Cash paid for interest and income taxes

2. Reconciliation schedule

3. Noncash investing and financing activities

Three categories of supplemental disclosure are associated with the statement of cash flows:


(continued)

21-47

Cash Paid For Interest and Income TaxesCash Paid For Interest and Income TaxesCash Paid For Interest and Income TaxesCash Paid For Interest and Income Taxes

• When the direct method is used, the amount of cash paid for interest and for income taxes are part of the Operating Activities section, so no additional disclosure is needed.

• When the indirect method is used, the amounts must be shown separately at the bottom of the cash flow statement or in an accompanying note.


(continued)

21-48

Reconciliation ScheduleReconciliation ScheduleReconciliation ScheduleReconciliation Schedule

• When the direct method is used, a schedule should be included that reconciles net income to cash from operations.

• The schedule is the same as the Operating Activities section prepared using the indirect method.


(continued)

21-49

Noncash Investing and Financing ActivitiesNoncash Investing and Financing ActivitiesNoncash Investing and Financing ActivitiesNoncash Investing and Financing Activities

• When a company has a significant noncash transaction, such as purchasing property, plant, and equipment by issuing debt or in exchange for shares of stock, these transactions must be disclosed in the notes to the financial statements.

• Western Resources exchanged common stock for land valued at $40,000.


21-50

International Cash Flow Statements

• The majority of the FASB decided in pre-codification SAFS No. 95 that since interest and dividends received are included in the computation of net income, they should be classified as operating activities.

• In IAS 7, the IASB allowed companies to classify interest and dividends received either as operating or investing activities.

• The majority of the FASB members ruled that interest paid should be treated as an operating activity.

(continued)

21-51


• IAS 7 allows dividends paid to be classified as either a financing activity (as in the U.S.) or as an operating activity.

• According to IAS 7, the amount of income taxes paid should be reported as an operating activity unless the income taxes can be specifically identified with a financing or investing activity.

(continued)

21-52


• The U.K. Accounting Standards Board revised its standards concerning the statement of cash flows in the revised version of FRS 1.

• The revised version specifies eight different categories for classifying cash flow transactions and represents the most innovate and, probably, the most useful standard for cash flow reporting currently in existence in the world.

(continued)

21-53

1. Operating activities2. Returns on investments and servicing of

finance3. Taxation4. Capital expenditures and financial

investments5. Acquisitions and disposals6. Equity dividends paid7. Management of liquid resources8. Financing


The eight cash flow categories specified in FRS 1 are as follows:

21-54

Kamila Software Illustration

Kamila Software develops, produces, and sells software. The company headquarters is located in Panaca, Nevada.

(continued)

21-55

1. In 2013, Kamila Software’s accounts receivable balance includes amounts related to both regular software sales and consulting projects.


(continued)

21-56

2. Over the past three years, Kamila’s systems consultants have worked on a total of nine projects (designated A through I). The total contract prices, and the amount of revenue recognized in each year with respect to these projects are given on Slide 21-57.


(continued)

21-57


(continued)

21-58


3. Both of Kamila’s buildings are leased. Both leases were signed on January 1, 2010. The factory is leased under a capital lease arrangement; the office building is leased under an operating lease arrangement. The office building lease payments are $100 per year. Under the office building lease contract, Kamila can elect to defer an annual payment for one year in exchange for a 20% payment surcharge. The factory lease payment is $30 per year.

(continued)

21-59


21-60

Chapter 21Chapter 21

The EndThe EndThe EndThe End

$

₵

21-1 intermediate financial accounting earl k. stice james d. stice © 2012 cengage learning...

Documents

outflow of cash

statement of cash flows21

cash balance

detailed cash inflow

detailed cash flow information

total cash collections

companys cash inflow

income statement