23-1 prepared by coby harmon university of california, santa barbara intermediat e accounting...
TRANSCRIPT
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Prepared by Prepared by Coby Harmon Coby Harmon
University of California, Santa BarbaraUniversity of California, Santa Barbara
IntermediatIntermediate e
AccountingAccounting
IntermediatIntermediate e
AccountingAccounting
Prepared by Prepared by Coby Harmon Coby Harmon
University of California, Santa BarbaraUniversity of California, Santa BarbaraWestmont CollegeWestmont College
INTERMEDIATE
ACCOUNTINGF I F T E E N T H E D I T I O N
Prepared byCoby Harmon
University of California, Santa BarbaraWestmont College
kikieesosowweeygandtygandtwarfiwarfieeldld
team for successteam for success
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PREVIEW OF CHAPTERPREVIEW OF CHAPTER
Intermediate Accounting15th Edition
Kieso Weygandt Warfield
2323
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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A Frenzied Focus on EarningsA Frenzied Focus on Earnings
Earnings-per-share usually makes the head-Earnings-per-share usually makes the head-lineslines
E.g. Yahoo!’s Earnings ScoreboardE.g. Yahoo!’s Earnings Scoreboardhttp://biz.yahoo.com/z/extreme.html
Yet, earnings don’t tell the whole storyYet, earnings don’t tell the whole story In fact, relying on earnings without looking at In fact, relying on earnings without looking at
cash flows is a recipe for misinterpretationcash flows is a recipe for misinterpretation
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Cash Flow: Cash Flow: Shining a Light on EarningsShining a Light on Earnings
Problem with earnings: can be manipulated Problem with earnings: can be manipulated through creative accountingthrough creative accounting GAAP requires accrual accounting, full of GAAP requires accrual accounting, full of
estimates and judgment calls . . . & gimmicksestimates and judgment calls . . . & gimmicks
Advantage of cash flow: much harder to Advantage of cash flow: much harder to fudge, provides a reality checkfudge, provides a reality check You either got (or paid) $$ or you didn’t. Period.You either got (or paid) $$ or you didn’t. Period.
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Buffetology:Buffetology:Mimicking the MasterMimicking the Master
Warren Warren Buffet,Buffet,
World’s Most World’s Most Famous Famous InvestorInvestor
- Uses a cash flow model as a major pillar of - Uses a cash flow model as a major pillar of investing strategyinvesting strategy
- Hard to argue with a guy who bought - Hard to argue with a guy who bought Berkshire Hathaway for $15/share and each Berkshire Hathaway for $15/share and each
share is worth over $100k today (22% share is worth over $100k today (22% average compound return)average compound return)
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Buffetology at WorkBuffetology at WorkExampleExample
Cash Flow Track Record of XYX Company 2003 2004 2005 2006 2007 2008 2009 2010 AVG
Free Cash Flow 145 223 224 290 313 274 252 238 259
Avg Growth Rate in FCF = 9.4%
Projected Cash Flows of XYZ Company 2011 2012 2013 2014 2015 2016 2017 2018 2019+TOTAL
Projected Cash Flows 283 310 339 371 406 444 486 531
PV of Projected CF, 8% 262 266 269 273 276 280 283 287 5667 7863
Market Cap Today (# shares times price) 9.53m * $585/sh 5575
Discount Percentage (stock is undervalued by 29%) 29%
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Putting Earnings on TrialPutting Earnings on Trial
When net earnings > oper. cash flow, it When net earnings > oper. cash flow, it raises suspicions of aggressive earnings raises suspicions of aggressive earnings management and should be investigated.management and should be investigated.
Furthermore, if this condition persists for Furthermore, if this condition persists for several periods, questions about viability several periods, questions about viability need to be raisedneed to be raised
Example: W.T. GrantExample: W.T. Grant
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23-9A Classic Example . . A Classic Example . .
..
W. T. Grant Co.W. T. Grant Co.W. T. Grant Co.W. T. Grant Co.““Retailing With A Difference”Retailing With A Difference”
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W.T. Grant Building, NYC, 1974W.T. Grant Building, NYC, 1974
W.T. Grant was the W.T. Grant was the largest U.S. retailer in largest U.S. retailer in
1970 and reported profits 1970 and reported profits almost right up until it’s almost right up until it’s bankruptcy in 1975. If bankruptcy in 1975. If investors had looked at investors had looked at its cash flows instead of its cash flows instead of profits, they would have profits, they would have seen a different story. seen a different story. The cash flows for all The cash flows for all
years (except two) in the years (except two) in the decade prior to decade prior to
bankruptcy were bankruptcy were negative. This should negative. This should
have been a tell-tale sign.have been a tell-tale sign.
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4040
2020
-20-20
00
-40-40
-100-100
Millions of Millions of DollarsDollars
1968196819661966 19701970 19721972 19741974
Working Capital Working Capital Provided By OperationsProvided By Operations
Net IncomeNet Income
Cash Flow Provided Cash Flow Provided by Operationsby Operations
What went wrong at WT Grant?What went wrong at WT Grant?
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W.T. Grant Collapse:W.T. Grant Collapse:A Catalyst for ChangeA Catalyst for Change
The bankruptcy of W.T. Grant helped launch The bankruptcy of W.T. Grant helped launch a campaign for better disclosure of cash a campaign for better disclosure of cash flows.flows.
A study of 45,000 firms that filed for A study of 45,000 firms that filed for bankruptcy in the 1980s showed that 60% bankruptcy in the 1980s showed that 60% had a profitable bottom line, but none had had a profitable bottom line, but none had positive operating cash flow.positive operating cash flow.
In 1987, the FASB finally got around to In 1987, the FASB finally got around to requiring the current cash flow statement requiring the current cash flow statement formatformat
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Summary: “Watch Cash Flow” Quoth Summary: “Watch Cash Flow” Quoth the Bankerthe Banker
Once upon a mid-night dreary as I pondered Once upon a mid-night dreary as I pondered weak and weary, over many a curious weak and weary, over many a curious volume of accounting lore,volume of accounting lore,
Seeking gimmicks (without scruple) to squeeze Seeking gimmicks (without scruple) to squeeze through some new loophole, suddenly I through some new loophole, suddenly I heard a knock at the door,heard a knock at the door,
Only this, and nothing moreOnly this, and nothing more
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Summary: “Watch Cash Flow” Quoth Summary: “Watch Cash Flow” Quoth the Bankerthe Banker
Then I felt a queasy tingling and I heard the Then I felt a queasy tingling and I heard the cash-a-jingling, as my fearsome banker cash-a-jingling, as my fearsome banker entered whom I’d oft’ seen beforeentered whom I’d oft’ seen before
His face was money-green and in his eyes His face was money-green and in his eyes there could be seen dollar-signs glittering as there could be seen dollar-signs glittering as he reckoned up the score.he reckoned up the score.
““Cash flow,” said the banker and nothing more.Cash flow,” said the banker and nothing more.
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Summary: “Watch Cash Flow” Quoth Summary: “Watch Cash Flow” Quoth the Bankerthe Banker
I had always thought it fine to show a jet-black I had always thought it fine to show a jet-black bottom line, but the banker yelled a bottom line, but the banker yelled a resounding “No,resounding “No,
Your receivables are high, mounting upwards Your receivables are high, mounting upwards to the sky, and write-offs loom, Watch cash to the sky, and write-offs loom, Watch cash flow,” he said. “Watch cash flow!”flow,” he said. “Watch cash flow!”
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Summary: “Watch Cash Flow” Quoth Summary: “Watch Cash Flow” Quoth the Bankerthe Banker
Then I tried to tell the story of our lovely Then I tried to tell the story of our lovely inventory, which though large is full of inventory, which though large is full of delightful stuff.delightful stuff.
But the banker saw its growth and with a might But the banker saw its growth and with a might oath, waved his arms and shouted “Enough!oath, waved his arms and shouted “Enough!
Pay the interest and don’t give any guff.”Pay the interest and don’t give any guff.”
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Summary: “Watch Cash Flow” Quoth Summary: “Watch Cash Flow” Quoth the Bankerthe Banker
Next I looked for items not of cash to replace Next I looked for items not of cash to replace the ever-outward flow of cashthe ever-outward flow of cash
But to keep things in the black, I held But to keep things in the black, I held depreciation back, to which the banker yelled depreciation back, to which the banker yelled “Rash.”“Rash.”
He quivered and his teeth began to gnashHe quivered and his teeth began to gnash
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Summary: “Watch Cash Flow” Quoth Summary: “Watch Cash Flow” Quoth the Bankerthe Banker
Mustering courage, I finally asked him for a Mustering courage, I finally asked him for a loan and he responded with a groan, that the loan and he responded with a groan, that the rate would be prime plus eightrate would be prime plus eight
And to guarantee my purity he’d insist on some And to guarantee my purity he’d insist on some security, all the assets plus the scalp upon security, all the assets plus the scalp upon my patemy pate
Only this, a sub-standard rateOnly this, a sub-standard rate
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Summary: “Watch Cash Flow” Quoth Summary: “Watch Cash Flow” Quoth the Bankerthe Banker
Though my bottom line is black, I am flat upon Though my bottom line is black, I am flat upon my back, my cash goes out fast and it comes my back, my cash goes out fast and it comes in slow.in slow.
The growth of my receivables is almost The growth of my receivables is almost unbelievable, the result is certain woeunbelievable, the result is certain woe
And I hear the banker utter an ominous growlAnd I hear the banker utter an ominous growl
““Watch cash flow,” he said. “Watch cash Watch cash flow,” he said. “Watch cash flow.”flow.”
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Where Does Where Does it Fit in?it Fit in?
The Statement of Cash FlowsThe Statement of Cash Flows
Cash Cash FlowsFlows
BSBS
ISIS
SCOSCOEE
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Primary purpose:
To provide information about a company’s cash receipts
and cash payments during a period.
Secondary objective:
To provide cash-basis information about the company’s
operating, investing, and financing activities.
LO 1
Preparation of Statement of Cash Flows
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Provides information to help assess:
1. Entity’s ability to generate future cash flows.
2. Entity’s ability to pay dividends and meet obligations.
3. Reasons for difference between net income and net cash
flow from operating activities.
4. Cash and noncash investing and financing transactions.
LO 1
Usefulness of the Statement of Cash Flows
Preparation of Statement of Cash Flows
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Income
Statement Items
Operating Activities
Changes in Investments and
Long-Term Asset Items
Investing Activities
Changes in Long-Term
Liabilities and Stockholders’
Equity
Financing Activities
LO 2
Classification of Cash Flows
Preparation of Statement of Cash Flows
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Illustration 23-1 Classification of Typical Cash Inflows and Outflows
LO 2
Classification of Cash Flows
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Illustration 23-1 Classification of Typical Cash Inflows and Outflows
LO 2
Classification of Cash Flows
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Statement of Cash Flows:Statement of Cash Flows: Connecting the Dots Connecting the Dots
Accrual Cash
Sales 1000 900 100 of uncollected sales
Cost of Sales 600 590 10 of unpaid inventory
Gross Profit 400 310Oper. Expenses 300 250 50 of depreciation
Net Income 100 60Borrowed $$ 50Paid Dividends 40Purchased Equip. 70Increase in cash 0
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Statement of Cash FlowsStatement of Cash Flows
OPERATING ACTIVITIES
Operating activities should provide cash . . . this is the cash
engine, the life blood of the company.
Net Income 100
Depreciation +50
Increase in Accounts Receivable -100
Increase in Accounts Payable +10
Net Cash from Oper. Activities +60
INVESTING ACTIVITIES Investing activities should use cash . . . This is how the engine is
kept running smoothlyPurchased Equipment -70
Net Cash used by Invest. Activities -70
FINANCING ACTIVITIESFinancing activities could either provide or use cash, depending on position in produce life cycle.
Dividends Paid -40
Borrowed Money +50
Net Cash from Fin. Activities +10
NET CHANGE IN CASH 0
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The basis recommended by the FASB for the statement of
cash flows is actually “cash and cash equivalents.” Cash
equivalents are short-term, highly liquid investments that are
both:
Readily convertible to known amounts of cash, and
So near their maturity that they present insignificant risk of
changes in interest rates.
Generally, only investments with original maturities of three
months or less qualify under this definition.
LO 2
Classification of Cash Flows
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The Product Life CycleThe Product Life Cycle
A series of phases all products go throughA series of phases all products go through The phases are often referred to as the: The phases are often referred to as the:
introductory phaseintroductory phase growth phasegrowth phase maturity phasematurity phase decline phase. decline phase.
The phase a company is in affects its cash The phase a company is in affects its cash flows.flows.
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Company Product Life
Cycle
LO 2
Classification of Cash Flows
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Introductory PhaseIntroductory Phase
To support asset purchases the company may To support asset purchases the company may issue stock or debt. Expect:issue stock or debt. Expect:
cash from operations to be negativecash from operations to be negative cash from investing to be negative.cash from investing to be negative. cash from financing to be positive.cash from financing to be positive.
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The company is striving to expand its production The company is striving to expand its production and salesand sales..
Expect:Expect: small amounts of cash to be generatedsmall amounts of cash to be generated
from operations. from operations. cash from investing to be negative.cash from investing to be negative. cash from financing to be positive.cash from financing to be positive.
Growth PhaseGrowth Phase
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Sales and production level-offSales and production level-offExpect:Expect: cash from operations to exceed investing cash from operations to exceed investing
needs.needs. cash from investing to be neutral.cash from investing to be neutral. cash from financing to be negative.cash from financing to be negative.
Maturity PhaseMaturity Phase
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Sales and production declineSales and production declineExpect:Expect: cash from operations to declinecash from operations to decline cash from investing to possibly become cash from investing to possibly become
positive.positive. cash from financing to possibly become cash from financing to possibly become
negativenegative
Decline PhaseDecline Phase
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Cash Flow Patterns: Start UpCash Flow Patterns: Start Up
MATCH: Moving ahead in faith . . . somebody MATCH: Moving ahead in faith . . . somebody believes in you and is backing it up with bucks believes in you and is backing it up with bucks (start-up pattern)(start-up pattern)
COMPANY: A B C D EOperating +500 +300 +300 -100 -200Investing -400 +100 +200 -200 +400Financing -100 +200 -500 +300 -200Net Incr (Decr) 0 +600 0 0 0
ANSWER: D, Start-up PatternANSWER: D, Start-up Pattern
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Cash Flow Patterns:Cash Flow Patterns:Normal FlowNormal Flow
MATCH: Going strong & ensuring strength for MATCH: Going strong & ensuring strength for tomorrow (normal cash flow)tomorrow (normal cash flow)
COMPANY: A B C D EOperating +500 +300 +300 -100 -200Investing -400 +100 +200 -200 +400Financing -100 +200 -500 +300 -200Net Incr (Decr) 0 +600 0 0 0
ANSWER: A, Normal PatternANSWER: A, Normal Pattern
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Cash Flow Patterns: MaturityCash Flow Patterns: Maturity
MATCH: Making cash-hungry creditors or owners MATCH: Making cash-hungry creditors or owners happy (maturity pattern)happy (maturity pattern)
COMPANY: A B C D EOperating +300 +300 +300 -100 -200Investing -400 +100 +200 -200 +400Financing +100 +200 -500 +300 -200Net Incr (Decr) 0 +600 0 0 0
ANSWER: C, Maturity PatternANSWER: C, Maturity Pattern
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Cash Flow Patterns:Cash Flow Patterns:Cash Build UpCash Build Up
MATCH: Hoarding cash, maybe for future takeover MATCH: Hoarding cash, maybe for future takeover or expansion .or expansion .
COMPANY: A B C D EOperating +300 +300 +300 -100 -200Investing -400 +100 +200 -200 +400Financing +100 +200 -500 +300 -200Net Incr (Decr) 0 +600 0 0 0
ANSWER: B, Cash Build-UpANSWER: B, Cash Build-Up
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Cash Flow Pattern: Decline StageCash Flow Pattern: Decline Stage
MATCH: Poor health and getting ready to die MATCH: Poor health and getting ready to die (liquidation)(liquidation)
COMPANY: A B C D EOperating +300 +300 +300 -100 -200Investing -400 +100 +200 -200 +400Financing +100 +200 -500 +300 -200Net Incr (Decr) 0 +600 0 0 0
ANSWER: E, Decline StageANSWER: E, Decline Stage
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LiquidityLiquidity
Liquidity is the ability of a business to meet its Liquidity is the ability of a business to meet its immediate obligations.immediate obligations.
One measure of liquidity is the current ratio. One measure of liquidity is the current ratio. A disadvantage of the current ratio is that it uses A disadvantage of the current ratio is that it uses
year-end balances of current assets and current year-end balances of current assets and current liabilities (may not be representative of a company's liabilities (may not be representative of a company's position during most of the year.) position during most of the year.)
Other measures of liquidity include free cash Other measures of liquidity include free cash flow, current debt coverage ratio, and debt flow, current debt coverage ratio, and debt coverage ratio.coverage ratio.
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Cash Provided By Operations Cash Provided By Operations
– – Capital ExpendituresCapital Expenditures
– – Dividends Paid Dividends Paid
== Free Cash Flow Free Cash Flow
Free Cash FlowFree Cash Flow
This concept is used heavily by Warren Buffet to value a company – see slides 6-7
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Assessing Liquidity and Assessing Liquidity and SolvencySolvencyLiquidity Liquidity is the ability to pay obligations expected is the ability to pay obligations expected to become due within the next year.to become due within the next year.
Using Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a Company
Illustration Illustration 12-1812-18
A value below 0.40 times is cause for A value below 0.40 times is cause for additional investigation.additional investigation.
SO 5 Use the statement of cash flows to evaluate a SO 5 Use the statement of cash flows to evaluate a company.company.
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Assessing Liquidity and Assessing Liquidity and SolvencySolvencySolvencySolvency is the ability of a company to survive over is the ability of a company to survive over the long term.the long term.
Illustration Illustration 12-1912-19
A ratio below 0.20 times is cause for A ratio below 0.20 times is cause for additional investigationadditional investigation..
Using Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a Company
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23-45 LO 2 Identify the major classifications of cash flows.LO 2 Identify the major classifications of cash flows.
Format of the Statement of Cash Format of the Statement of Cash FlowsFlows
Format of the Statement of Cash Format of the Statement of Cash FlowsFlows
Order of Presentation:Order of Presentation:
1.1. Operating activities. Operating activities.
2.2. Investing activities.Investing activities.
3.3. Financing activities.Financing activities.
Direct MethodDirect Method
Indirect MethodIndirect Method
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Indirect and Direct MethodsIndirect and Direct Methods
The choice of methods affects only the The choice of methods affects only the operating operating activities sectionactivities section; ; investing & financing activities investing & financing activities sections are the same.sections are the same.
Both methods arrive at the same total amount for Both methods arrive at the same total amount for “Net cash” provided by operating activities.“Net cash” provided by operating activities.
The methods differ in disclosing the items that The methods differ in disclosing the items that make up the total operating activities amount.make up the total operating activities amount.
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Indirect and Direct MethodsIndirect and Direct Methods
Direct MethodDirect Method: move down the income statement : move down the income statement from top to bottom directly converting each from top to bottom directly converting each section from an accrual to a cash basissection from an accrual to a cash basis
Indirect MethodIndirect Method: start with net income and : start with net income and adjust for all non-cash revenue and expensesadjust for all non-cash revenue and expenses
If the direct method is used, a reconciliation to net If the direct method is used, a reconciliation to net income must also be provided (which essentially income must also be provided (which essentially means the indirect method must also be done.)means the indirect method must also be done.)
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Indirect MethodIndirect Method
Most companies (98.8%) favor the indirect Most companies (98.8%) favor the indirect method for the following reasons:method for the following reasons: it is easier to prepareit is easier to prepareThe direct method is not only harder to prepare, The direct method is not only harder to prepare,
but it essentially requires that the indirect method but it essentially requires that the indirect method also be done (which is twice as much work)also be done (which is twice as much work)
it focuses on the differences between net income it focuses on the differences between net income and net cash flow from operating activitiesand net cash flow from operating activities
it tends to reveal less company information to it tends to reveal less company information to competitors.competitors.
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Statement Statement of Cash of Cash FlowsFlows
Statement Statement of Cash of Cash FlowsFlows
Cash flows from operating activities:Net income 145,000$
Adjustments to reconcile net income to net cashprovided by operating activities:
Depreciation expense 9,000 Loss on sale of equipment 3,000 Decrease in accounts receivable 10,000 Increase in inventory (5,000) Increase in prepaid expenses (4,000) Increase in accounts payable 16,000 Decrease in income taxes payable (2,000)
Net cash provided by operating activities 172,000 Cash flows from investing activities:
Purchase of building (120,000) Purchase of equipment (25,000) Sale of equipment 4,000
Net cash used by investing activities (141,000) Cash flows from financing activities:
Issuance of common stock 20,000 Payment of cash dividends (29,000)
Net cash used by financing activities (9,000) Net increase in cash 22,000 Cash at beginning of period 33,000 Cash at end of period 55,000$
IndirecIndirect t
MethoMethodd
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Statement of Cash Flows-Direct MethodStatement of Cash Flows-Direct MethodStatement of Cash Flows-Direct MethodStatement of Cash Flows-Direct Method
Statement of Statement of cash cash flows,direct flows,direct methodmethod
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Format of the Statement of Cash Flows
Illustration 23-2
LO 2
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Three Sources of Information:
1. Comparative balance sheets.
2. Current income statement data.
3. Selected transaction data.
Three Major Steps:
Step 1. Determine change in cash.
Step 2. Determine net cash flow from
operating activities.
Step 3. Determine net cash flows from
investing and financing activities. LO 2
Steps in Preparation
Preparation of Statement of Cash Flows
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Illustration: Tax Consultants Inc. started on January 1, 2013,
when it issued 60,000 shares of $1 par value common stock
for $60,000 cash. The company rented its office space,
furniture, and equipment, and performed tax consulting
services throughout the first year.
The comparative balance sheets at the beginning and end of
the year 2013 appear in Illustration 23-3. Illustration 23-4
shows the income statement and additional information for
Tax Consultants.
LO 3
Illustrations—Tax Consultants Inc.
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Illustration 23-3Illustration 23-3Comparative Balance Sheets, Tax Consultants Inc., Year 1
Illustration 23-4Income Statement, Tax Consultants Inc., Year 1
Illustrations—Tax Consultants Inc.
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Step 1: Determine the Change in CashIllustration 23-3
LO 3
Illustrations—Tax Consultants Inc.
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Company must determine revenues and expenses on a
cash basis.
Eliminate the effects of income statement transactions
that do not result in an increase or decrease in cash.
Convert net income to net cash flow from operating
activities through either a direct method or an indirect
method.
Step 2: Determine the Net Cash Flow from Operating Activities
LO 4
Illustrations—Tax Consultants Inc.
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Illustration 23-5Net Income versus Net Cash Flow from Operating Activities
LO 4
Illustrations—Tax Consultants Inc.
Step 2: Determine the Net Cash Flow from Operating Activities
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Accounts Receivable
1/1/13 Balance
0Revenues
125,000
Receipts from customers
89,00012/31/13 Balance
36,000
Increase in Accounts Receivable—Indirect Method
Illustration 23-6
Illustrations—Tax Consultants Inc.
LO 4
Accounts receivable increased by $36,000 (from $0 to $36,000)
during the year.
When the Accounts Receivable balance increases, cash receipts are
lower than revenue earned under the accrual basis.
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Accounts Receivable
1/1/13 Balance
0Revenues
125,000
Receipts from customers
89,00012/31/13 Balance
36,000
Increase in Accounts Receivable—Indirect MethodIllustration 23-6
Illustrations—Tax Consultants Inc.
LO 4
The increase in accounts receivable is subtracted from net income to
arrive at net cash provided by operating activities.Illustration 23-7
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Increase in Accounts Payable—Indirect Method
Illustrations—Tax Consultants Inc.
LO 4
Accounts payable increased by $5,000 during the year.
When accounts payable increase during the year, expenses on an
accrual basis exceed those on a cash basis.
Illustration 23-7
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23-63 LO 4
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Tax Consultants Inc.
Illustration 23-3
Illustration 23-8
Step 3: Determine Net Cash Flows from Investing and Financing Activities
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Tax Consultants Inc.
Illustration 23-3
Illustration 23-8
Step 3: Determine Net Cash Flows from Investing and Financing Activities
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Tax Consultants Inc.
Illustration 23-3
Illustration 23-8
Step 3: Determine Net Cash Flows from Investing and Financing Activities
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Tax Consultants Inc.
Illustration 23-3
Illustration 23-8
Step 3: Determine Net Cash Flows from Investing and Financing Activities
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Tax Consultants Inc.
Illustration 23-3
Illustration 23-8
Step 3: Determine Net Cash Flows from Investing and Financing Activities
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Statement of Cash Flows—2013Illustration 23-8
Illustrations—Tax Consultants Inc.
LO 5
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Illustration: Norman Company’s financial statements for the year
ended December 31, 2014, contained the following condensed
information.
Operating Activities — Indirect Method
2014 2013 Change
Service revenue 840,000$ Operating expenses 624,000 Depreciation expense 60,000 Loss on sale of equipment 26,000
Income before income tax 130,000 Income tax 40,000
Net income 90,000$
Accounts receivable 37,000$ 59,000$ (22,000)$ Accounts payable 46,000 31,000 15,000 Income taxes payable 4,000 8,500 (4,500)
LO 5
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Cash flows from operating activities
Net income 90,000$
Adjustment to reconcile net income
to net cash provided by operating activities:
Depreciation expense 60,000
Loss on sale of equipment 26,000
Decrease in accounts receivable 22,000
Increase in accounts payable 15,000
Decrease in income taxes payable (4,500)
Net cash provided by operating activities 208,500
Prepare the operating activities section of the statement of cash flows
using the indirect method (Step 2).
Advance slide to uncover solution
Operating Activities — Indirect Method
LO 5
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2014 2013 Change
Service revenue 840,000$ Operating expenses 624,000 Depreciation expense 60,000 Loss on sale of equipment 26,000
Income before income tax 130,000 Income tax 40,000
Net income 90,000$
Accounts receivable 37,000$ 59,000$ (22,000)$ Accounts payable 46,000 31,000 15,000 Income taxes payable 4,000 8,500 (4,500)
Norman Company’s financial statements for the year ended December
31, 2014, contained the following condensed information.
Assume accounts payable relates to
operating expenses.
Operating Activities — Direct Method
LO 5
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Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
Illustration 23-22
Accounts Receivable
1/1/14 Balance
59,000Revenues
840,000
Receipts from customers
862,00012/31/14 Balance
37,000
Operating Activities — Direct Method
LO 5
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Accounts Payable
1/1/14 Balance
31,000Operating expenses
624,00012/31/14 Balance
46,000
Illustration 23-24
Payments to suppliers
609,000
Operating Activities — Direct Method
Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
LO 5
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Income Tax Payable
1/1/14 Balance
8,500Income tax expense
40,00012/31/14 Balance
4,000
Payments for income tax
44,500
Illustration 23-24
Operating Activities — Direct Method
Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
LO 5
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Cash flows from operating activities
Cash receipts from customers $ 862,000
Cash paid for operating expenses (609,000)
Cash paid for income taxes (44,500)
Net cash provided by operating activities $ 208,500
Operating Activities — Direct Method
Prepare the operating activities section of the statement of cash flows
using the Direct method (Step 2).
LO 5
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Illustration: (a) Plant assets that had cost $25,000 6 years before
and were being depreciated on a straight-line basis over 10 years
with no estimated scrap value were sold for $5,300.
Step 3: Determine Net Cash Flow from Investing and Financing Activities
Plant assets (cost) 25,000$
Accumulated depreciation ([$25,000 ÷ 10] x 6) 15,000
Book value at date of sale 10,000
Sale proceeds (5,300)
Loss on sale 2,700$
LO 5
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Statement of Cash Flows
Cash flow from operating activities
Net income (loss) (50,000)$
Adjustment to reconcile net income to cash:
Loss on sale 2,700
Depreciation expense 22,000
Gain on sale (9,000)
Cash from operations (34,300)
Cash flow from investing activities
Sale of plant assets 5,300
Sale of land 39,000
Cash from investing activities 44,300
Cash flow from financing activities
Sale of common stock 330,000
Purchase of company stock (47,000)
Cash from financing activities 283,000
Net Change in Cash 293,000$
Investing and Financing Activities
O
I
F
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(b): During the year, 10,000 shares of common stock with a
stated value of $10 a share were issued for $33 a share.
Shares sold 10,000
Market value per share 33.00$
Value of shares 330,000$
Investing and Financing Activities
LO 5
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Statement of Cash Flows
Cash flow from operating activities
Net income (loss) (50,000)$
Adjustment to reconcile net income to cash:
Loss on sale 2,700
Depreciation expense 22,000
Gain on sale (9,000)
Cash from operations (34,300)
Cash flow from investing activities
Sale of plant assets 5,300
Sale of land 39,000
Cash from investing activities 44,300
Cash flow from financing activities
Sale of common stock 330,000
Purchase of company stock (47,000)
Cash from financing activities 283,000
Net Change in Cash 293,000$
O
I
F
Investing and Financing Activities
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(d): The company sustained a net loss for the year of
$50,000. Depreciation amounted to $22,000, and a gain of
$9,000 was realized on the sale of land for $39,000 cash.
Investing and Financing Activities
LO 5
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Statement of Cash Flows
Cash flow from operating activities
Net income (loss) (50,000)$
Adjustment to reconcile net income to cash:
Loss on sale 2,700
Depreciation expense 22,000
Gain on sale (9,000)
Cash from operations (34,300)
Cash flow from investing activities
Sale of plant assets 5,300
Sale of land 39,000
Cash from investing activities 44,300
Cash flow from financing activities
Sale of common stock 330,000
Purchase of company stock (47,000)
Cash from financing activities 283,000
Net Change in Cash 293,000$
O
I
F
Investing and Financing Activities
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(h): During the year, treasury stock costing $47,000 was
purchased.
Investing and Financing Activities
LO 5
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Statement of Cash Flows
Cash flow from operating activities
Net income (loss) (50,000.0)$
Adjustment to reconcile net income to cash:
Loss on sale 2,700
Depreciation expense 22,000
Gain on sale (9,000)
Cash from operations (34,300)
Cash flow from investing activities
Sale of plant assets 5,300
Sale of land 39,000
Cash from investing activities 44,300
Cash flow from financing activities
Sale of common stock 330,000
Purchase of company stock (47,000)
Cash from financing activities 283,000
Net Change in Cash 293,000$
O
I
F
Investing and Financing Activities
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Sources of Information for the Statement of Cash Flows
1. Comparative balance sheets.
2. An analysis of the Retained Earnings account.
3. Write-downs, amortization charges, and similar “book”
entries, such as depreciation, because they have no
effect on cash.
LO 6
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Net Cash Flow from Operating Activities—Indirect Versus Direct Method
Adjustments Needed to Determine Net Cash Flow from Operating Activities.
Indirect Method
Illustration 23-18
LO 7
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Illustration 23-21
Companies adjust each item in the income statement from the accrual basis to the cash basis.
Direct Method
LO 7
Net Cash Flow from Operating Activities—Indirect Versus Direct Method
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Special Rules Applying to Direct and Indirect Methods
Net Cash Flow from Operating Activities—Indirect Versus Direct Method
Companies that use the direct method are required, at a minimum, to
report separately:
Receipts
1.Cash collected from customers (including lessees, licensees, etc.).
2.Interest and dividends received.
3.Other operating cash receipts, if any.
LO 7
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Special Rules Applying to Direct and Indirect Methods
Net Cash Flow from Operating Activities—Indirect Versus Direct Method
Companies that use the direct method are required, at a minimum, to
report separately:
Payments
1.Cash paid to employees and suppliers of goods or services
(including suppliers of insurance, advertising, etc.).
2.Interest paid.
3.Income taxes paid.
4.Other operating cash payments, if any.LO 7
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Special Problems in Statement Preparation
Amortization of limited-life intangible assets.
Amortization of bond discount or premium.
Depreciation and Amortization
Postretirement Benefit Costs
Company must adjust net income by the difference
between cash paid and the expense reported.
LO 8
Adjustments to Net Income
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Adjustments to Net Income
Affect net income but have no effect on cash.
Changes in Deferred Income Taxes
Equity Method of Accounting
Net increase in the investment account does not affect
cash flows.
Company must deduct the net increase from net income
to arrive at net cash flow from operating activities.
LO 8
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A loss is added to net income to compute net cash flow
from operating activities because the loss is a noncash
charge in the income statement.
Company reports a gain in the statement of cash flows as
part of the cash proceeds from the sale of equipment
under investing activities, thus it deducts the gain from
net income to avoid double-counting—once as part of net
income and again as part of the cash proceeds from the
sale.
Loss and Gains
LO 8
Adjustments to Net Income
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Cash is not affected by recording the expense.
The company must increase net income by the amount of
compensation expense from share options in computing
net cash flow from operating activities.
Stock Options
LO 8
Adjustments to Net Income
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Companies should report either as investing activities or
as financing activities cash flows from extraordinary
transactions and other events whose effects are included
in net income, but which are not related to operations.
Extraordinary Items
LO 8
Adjustments to Net Income
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Because an increase in Allowance for Doubtful Accounts results from
a charge to bad debt expense, a company should add back an
increase in Allowance for Doubtful Accounts to net income to arrive
at net cash flow from operating activities.
Indirect Method
Illustration 23-28Accounts ReceivableBalances, Redmark Co.
LO 8
Special Problems
Accounts Receivable (Net)
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Accounts Receivable (Net)
One method of presenting this information in the statement of
cash flows:
Indirect Method
Illustration 23-29
LO 8
REDMARK CO.Statement of Cash Flows (Partial)
For The Year 2014
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Accounts Receivable (Net)
Alternate method (net approach) of presenting this
information in the statement of cash flows:Illustration 23-30
LO 8
REDMARK CO.Statement of Cash Flows (Partial)
For The Year 2014
Indirect Method
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Accounts Receivable (Net)
Company should not net Allowance for Doubtful Accounts
against Accounts Receivable.
Direct Method
Illustration 23-31
LO 8
REDMARK CO.Income Statement For The Year 2014
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Accounts Receivable (Net)
Company should not net Allowance
for Doubtful Accounts against
Accounts Receivable.
Illustration 23-31
Cash sales should be reported at $85,000 ($100,000 - 9,000 - 6,000).
Increase in Accounts Receivable
Illustration 23-32
LO 8
Direct MethodREDMARK CO.
Income Statement For The Year 2014
REDMARK CO.Statement of Cash Flows (Partial)
For The Year 2014
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Some changes in working capital, although they affect cash,
do not affect net income.
Purchase of short-term available-for-sale securities.
Issuance of a short-term nontrade note payable for cash.
Cash dividend payable.
LO 8
Special Problems
Other Working Capital Changes
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Illustration: If the net loss is $50,000 and the total amount of
charges to add back is $60,000, then net cash provided by
operating activities is $10,000.
Illustration 23-33Computation of Net CashFlow from OperatingActivities—Cash Inflow
LO 8
Special Problems
Net Losses
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Common noncash transactions that a company should report
or disclose:
1. Acquisition of assets by assuming liabilities (including capital
lease obligations) or by issuing equity securities.
2. Exchanges of nonmonetary assets.
3. Refinancing of long-term debt.
4. Conversion of debt or preferred stock to common stock.
5. Issuance of equity securities to retire debt.
LO 8
Special Problems
Significant Noncash Transactions
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6. Identify sources of information for a statement of cash flows.
7. Contrast the direct and indirect methods of calculating net cash flow from operating activities.
8. Discuss special problems in preparing a statement of cash flows.
9. Explain the use of a worksheet in preparing a statement of cash flows.
After studying this chapter, you should be able to:
LEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVESLEARNING OBJECTIVES
1. Describe the purpose of the statement of cash flows.
2. Identify the major classifications of cash flows.
3. Prepare a statement of cash flows.
4. Differentiate between net income and net cash flow from operating activities.
5. Determine net cash flows from investing and financing activities.
Statement of Cash Statement of Cash Flows Flows 2323
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Use of a Worksheet
A worksheet involves the following steps.
Step 1. Enter the balance sheet accounts and their beginning and
ending balances in the balance sheet accounts section.
Step 2. Enter the data that explain the changes in the balance
sheet accounts and their effects on the statement of cash flows in
the reconciling columns of the worksheet.
Step 3. Enter the increase or decrease in cash on the cash line
and at the bottom of the worksheet. This entry should enable the
totals of the reconciling columns to be in agreement.
LO 9
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RELEVANT FACTS - Similarities
Both GAAP and IFRS require that companies prepare a statement of cash flows.
Both IFRS and GAAP require that the statement of cash flows should have three major sections—operating, investing, and financing—along with changes in cash and cash equivalents.
Similar to GAAP, the cash flow statement can be prepared using either the indirect or direct method under IFRS. For both IFRS and GAAP, most companies use the indirect method for reporting net cash flow from operating activities.
The definition of cash equivalents used in IFRS is similar to that used in GAAP.
LO 10 Compare the statement of cash flows under GAAP and IFRS.
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RELEVANT FACTS - Differences
A major difference in the definition of cash and cash equivalents is that in certain situations, bank overdrafts are considered part of cash and cash equivalents under IFRS(which is not the case in GAAP). Under GAAP, bank overdrafts are classified as financing activities.
IFRS requires that non-cash investing and financing activities be excluded from the statement of cash flows. Instead, these non-cash activities should be reported elsewhere. This requirement is interpreted to mean that non-cash investing and financing activities should be disclosed in the notes to the financial statements instead of in the financial statements. Under GAAP, companies may present this information in the cash flow statement.
LO 10
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RELEVANT FACTS - Differences
One area where there can be substantive differences between IFRS and GAAP relates to the classification of interest, dividends, and taxes. IFRS provides more alternatives for disclosing these items, while GAAP requires that except for dividends paid (which are classified as a financing activity), these items are all reported as operating activities.
LO 10
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ON THE HORIZON
Presently, the IASB and the FASB are involved in a joint project on the presentation and organization of information in the financial statements. With respect to the cash flow statement specifically, the notion of cash equivalents will probably not be retained. The definition of cash in the existing literature would be retained, and the statement of cash flows would present information on changes in cash only. In addition, the IASB and FASB favor presentation of operating cash flows using the direct method only. This approach is generally opposed by the preparer community.
LO 10
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Which of the following is true regarding the statement of cash flows
under IFRS?
a. The statement of cash flows has two major sections—operating
and nonoperating.
b. The statement of cash flows has two major sections—financing
and investing.
c. The statement of cash flows has three major sections—
operating, investing, and financing.
d. The statement of cash flows has three major sections—
operating, non-operating, and financing.
IFRS SELF-TEST QUESTION
LO 11
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In the case of a bank overdraft:
a. GAAP typically includes the amount in cash and cash
equivalents.
b. IFRS typically includes the amount in cash equivalents but not
in cash.
c. GAAP typically treats the overdraft as a liability, and reports the
amount in the financing section of the statement of cash flows.
d. IFRS typically treats the overdraft as a liability, and reports the
amount in the investing section of the statement of cash flows.
IFRS SELF-TEST QUESTION
LO 11
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For purposes of the statement of cash flows, under IFRS interest paid
is treated as:
a. an operating activity in all cases.
b. an investing or operating activity, depending on use of the
borrowed funds.
c. either a financing or investing activity.
d. either an operating or financing activity, but treated consistently
from period to period.
IFRS SELF-TEST QUESTION
LO 11
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Copyright © 2013 John Wiley & Sons, Inc. All rights reserved.
Reproduction or translation of this work beyond that permitted in
Section 117 of the 1976 United States Copyright Act without the
express written permission of the copyright owner is unlawful.
Request for further information should be addressed to the
Permissions Department, John Wiley & Sons, Inc. The purchaser
may make back-up copies for his/her own use only and not for
distribution or resale. The Publisher assumes no responsibility for
errors, omissions, or damages, caused by the use of these
programs or from the use of the information contained herein.
Copyright