Intermediate Accounting II Lecture 9

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<p>Intermediate Accounting, Eighth Canadian Edition</p> <p>Chapter 22 Statement of Cash Flows1Usefulness of the Statement of Cash FlowsThe information may help users (investors, creditors, and others) assess the following:Liquidity and solvency i.e. the entitys ability to generate future cash flows and its needs for cash resourcesThe amounts, timing, and uncertainty of future cash flows The reasons why net income and net cash flow from operating activities differ 2Cash and Cash EquivalentsCashCash on handDemand depositsCash EquivalentsInvestments that areShort term,Highly liquidReadily convertible to known amounts of cash, andSubject to an insignificant risk of change in valueAll references to Cash include Cash Equivalentswhen discussing the Statement of Cash Flows3Beyond 60 days the financial instruments are too subject to a change in value otherwise you would have to justify otherwise.IAS 7 STATEMENT OF CASH FLOWSInterest and dividends recognized as either operating, financing or investing activityPresentation must be consistentStrong recommendation to use direct method (exposure draft on f/s presentation requiring use of direct method-met with significant resistance)The Cash Flow StatementThe cash flow statement provides information about:the cash receipts (cash inflows), anduses of cash (cash outflows) during the year Inflows and outflows are reported for:operating activitiesinvesting activities, andfinancing activities during the year5Cash Flow ClassificationsOperating Activities-Direct MethodThe cash flows resulting from the primary revenue-producing activities of the business, such as Collections from customersPayments to suppliersPayments to employeesPayments to CRA for taxCash flow provided by operating activities necessary for long term sustainability of the business (i.e. to take advantage of new investment opportunities, to pay dividends without seeking external financing etc.)6Sales influenced by accounts receivable and deferred revenueExampleSales Balance of $1,000,000A/R 50,000Deferred Revenue 100,000</p> <p>Cost of Sales Balance of $600,000A/P 100,000Inventory 200,000</p> <p>Wages Expense of $100,000- Wages Payable 20,000Sales $1,000,000Increase in A/R - 50,000Increase in Def Rev 100,000 $1,050,000</p> <p>COS $(600,000)Increase in A/P 100,000Increase in Inv (200,000) $(700,000)</p> <p>Wages $(100,000)Decrease in Wages Payable (20,000) $(120,000)Impact on Cash Flows</p> <p>Change in CashChange in CashChange in Cash7Pay attention to cash flow issues with interest expense that is dependent on interest payable and amortization of discount or premium on long-term debt.Cash Flow ClassificationsInvesting ActivitiesThe acquisition and disposal of long term assets and long-term investmentsExamples include:Purchase/disposal of capital assets (tangible and intangible)Cash receipts from the disposal of assets mentioned aboveCash payments to acquire equity or debt instrumentsCash receipts from the disposal of equity or debt instrumentsCash flow generated by investing activities shows if the business is investing in additional long term assets that will generate profits and increase cash flows in the future8Cash Flow ClassificationsFinancing ActivitiesChanges in long-term debt or equity capitalExamples include:Issuing debt, or repayment of debtIssuing new shares, or repurchase or currently outstanding sharesCash payments by a lessee for the reduction of the outstanding obligation related to a finance leaseProvides information to assess potential for future claims to entitys cash, extent of debt and increased interest charges9Under the indirect method two current liabilities that are not operating cash flows include current portions of long-term debt and dividends payable. You must look at dividends payable in linkage to retained earnings in case dividends may have been paid and additionally some declared during the year.Significant Noncash TransactionsTransactions that do not involve the direct receipt or disbursement of cash in the periodExamples:Assets acquired by assuming debt, or issuing sharesExchanges of non-monetary assetsConversion of debt to equityNoncash transactions are not reported on the Statement of Cash FlowsIf material, they are reported as notes to the statement or in a supplementary schedule to the financial statements10Preparing a Statement of Cash FlowsTwo methods of preparing the operating cash flow section of the Statement of Cash Flows:Indirect methodDirect methodIndirect method derives operating cash flows from accrual basis income statementDirect method determines operating cash flows directly for each operating source or use of cash11Cash Flow from Operations: Indirect Method ConceptNet Income+Earned RevenuesExpensesIncurredOperatingcash flowEliminatenon-cash revenuesEliminatenon-cash charges12The Statement of Cash Flows: Indirect MethodAccrual Basis StatementsCash Flow StatementIncome Statement itemsand changes in non-cash operating currentassets and current liabilitiesOperating activities:Adjust net income for accruals,non-cash charges and non-operating gains/lossesBalance Sheet: Changes in Non-Current AssetsInvesting activities:Inflows from sale of assets and outflows for purchases of assetsBalance Sheet:Changes in Non-CurrentLiabilities and EquityFinancing activities:Inflows and outflows from loanand equity transactions 13Format of the Statement of Cash Flows (Indirect Method)Cash flows from operating activities:Net Income (Loss) $ XXXAdjustments (List individual adjustments) $ XXNet cash flow from operating activities $ XXXCash flows from investing activities:(List individual inflows and outflows) $ XXNet cash flow from investing activities $ XXXCash flows from financing activities:(List individual inflows and outflows) $ XXNet cash flow from financing activities $ XXXChange in cash $ XXX14Dont add the total column figures for Cash Flow from operating activities, investing, and financing activities. WILL NOT BE MARKED ON THESE TOTALS.Format of the Statement of Cash Flows (Direct Method)Cash flows from operating activities:Cash receipts (individually): Inflows $ XXXCash payments (separately): Outflows ($ XXX)Net cash flow from operating activities $ XXX15Other ItemsIncome statement gains and losses on disposal of long-term assets must be adjusted in determining cash from operations. Why?These result from investing activities, not operating activities andThe amount of the cash flow is the proceeds on disposal, not the gain or loss 16Other ItemsIncome statement gains and losses on redemption of long-term debts must be adjusted in determining cash from operations. Why?These result from financing activities, not operating activities andThe amount of the cash flow is the amount paid to redeem the debt, not the gain or loss 17STATEMENT OF CASH FLOWS-COMPLEX TRANSACTIONSRevaluation modelAdjustments to Revaluation Surplus-OCIRevaluation LossesReversal of revaluation lossesImpairmentInvestmentsFVTPLAFSEquityInvestment measured at costInvestment accounted for under equity methodLong term debtCurrent portion of ltdInterest measured under the effective interest rate methodEquityShare based paymentsCASH FLOW-OTHER ISSUESCAPITAL LEASENo recognition at inception of the leaseSubsequent payments, financing activityDepreciation, operating cash flowCURRENT PORTION OF LONG TERM DEBTNot part of operating working capitalCASH FLOW-OTHER ISSUESLONG TERM DEBTInterest expense must be adjusted for discount/premium amortizationSHARE BASED PAYMENTExercise of options increases cash flow from investingCompensation expense related to options non-cash flowSHARE REPURCHASECash flow only relates to amount paid to obtain sharesIMPAIRMENTNon-cash adjustment in cash flow from operationsCash Flow per Share InformationPer CICA Handbook Section 1540, cash flow per share should not be reported in financial statements, except if payable to ownersIAS 7 permits the disclosure of cash flow per share21Special Items: Capital assetsGiven: 2008 2007Property, plant, and equipment $277,000 $247,000Accumulated depreciation (178,000) ( 167,000)</p> <p>Other information:Depreciation expense$ 33,000Gain on sale of equipment$ 14,500During 2008, equipment costing $45,000 was sold for cashPresent relevant T- accounts and cash flow information. 22Special Items: Capital assetsPP&amp;E247,000Beg.45,000Dr.Cr.202,000277,000End.75,000Cash Outflow (Investing Section)Accum Dep.22,000Beg.167,000Dr.Cr.33,000178,000End.Cash Inflow (Operations Section)200,000INDIRECT METHODOriginal Cost$45,000Accumulated Depreciation (22,000)Net Book Value 23,000Gain on Sale 14,500Proceeds on Sale 37,500Cash Inflow (Investing Section)Cash Outflow (Operations Section)*Gains are non-cash and must be added back to net income under the direct method.23FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME20092008FVTOCI $950,000 $800,000OCI 190,000 210,000</p> <p>During the year, investments were re-measured to fair valueDuring the year, the company sold investments having a fair value of $110,000 and an original cost of $90,000 for $150,000Purchased investments with a fair value of $260,000 for cashFAIR VALUE THROUGH OTHER COMPREHENSIVE INCOMEFair Value Through Other Comprehensive IncomeOther Comprehensive IncomeInvestmentsDr.Cr.Dr.Cr.800,00040,000150,000950,000260,000210,00040,000190,00060,000Tombstone RevaluationDr. Fair Value Through Other Comprehensive Income 40,000Cr. Other Comprehensive Income 40,000(150,000 110,000FV)Dr. Cash150,000Cr. Fair Value Through Other Comprehensive Income150,000Dr. Other Comprehensive Income 60,000Cr. Retained Earnings 60,000(90,000 held @ orig. cost 150,000 sold)Cash Outflow (Investing Section)AcquisitionsCash Inflow (Investing Section) Proceeds on DispositionSHARE-BASED PAYMENT20092008Ordinary shares$1,700,000$1,000,000Contributed surplus-options 690,000 600,000</p> <p>During the year, the company granted 100,000 options having a fair value of $600,000. In the current year, compensation expense related to options amounting to $300,000 was recorded.During the year, 30,000 options having a fair value of $150,000 were exercised for an average strike price of $12.00A further $60,000 of options expired during the year.SHARE-BASED PAYMENTCommon SharesContributed SurplusDr.Cr.Dr.Cr.510,0001,000,0001,700,000190,000600,00060,000690,000150,000Dr. Compensation Expense300,000Cr. Contributed Surplus Options300,000Dr. Cash360,000Dr. Contributed Surplus Options150,000Cr. Common Shares510,000Dr. Contributed Surplus Options 60,000Cr. Contributed Surplus Expired Options 60,000Cash Inflow (Operations Section) *Under Indirect Method Net Income includes this and must be added back since it is a non-cash item300,000Cash Inflow (Financing Section)Cash Inflow (Financing Section) Issuance of SharesINVESTMENT IN ASSOCIATE20092008Investment in Associate$650,000$320,000Income from Associate 300,000 </p> <p>During the year, the company purchased additional shares in the Associate for $400,000 by issuing common shares.Associate means we have control of at least 20% (significant influence). Must use the equity method for accounting this.28INVESTMENT IN ASSOCIATEInvestments in AssociateDr.Cr.300,000320,0001,020,000370,000Cash Inflow (Investing Section)400,000650,000Cash Outflow (Operations Section) *due to exclusion from income since it is non-cash incomeNOT CASH CHANGE (would be assumed a cash outflow investing section but since shares were used in exchange to pay it is not cash flowDr. Investment in Associate300,000Cr. Income from Associate300,000Dr. Investment in Associate400,000Cr. Common Shares400,000Dr. Cash370,000Cr. Investment in Associate370,000(to reflect dividend received from the investee)29Handout #18Additional information from the accounting records:During 2005, $6 million of customer accounts were written off as uncollectible.A machine originally costing $70 million that was one-half depreciated was rendered unusable by a rare flood. Most major components of the machine were unharmed and were sold for $17 million.The preferred shares of Tory Corporation was purchased for $25 million as a long-term investment.Land costing $46 million was acquired by issuing $23 million cash and a 15-percent, four-year, $23 million note payable to the seller.A building was acquired by an issue of $82 million bonds payable.$60 million of bonds were retired at maturity.In February, Arduous issued a 4-percent stock dividend (four million shares). The market price of the common shares were $7.50 per share at that time.Required:Prepare the cash flow statement of Arduous Company for the year ended December 31, 2005. Present cash flows from operating activities by the direct method.ARDUOUS COMPANYIncome StatementFor the year ended December 31, 2005($ in millions)RevenuesSales Revenue$410Investment Revenue13$423ExpensesCost of goods sold180Salaries expense65Depreciation expense12Patent amortization expense2Bad debt expense8Insurance expense7Bond interest expense28Loss on disposal of equipment due to flood18Income tax expense36356Net Income$ 67ARDUOUS COMPANYComparative Balance SheetsDecember 31, 2005 and 2004 ($ in millions)Assets20052004Cash$125$81Accounts receivable200202Less: Allowance for doubtful accounts(10)(8)Investment revenue receivable64Inventory205200Prepaid insurance48Long-term investment156125Land196150Buildings and equipment412400Less: Accumulated depreciation(97) (120)Patent3032$1,227$1,074LiabilitiesAccounts payable$50$65Salaries payable611Bond interest payable84Income tax payable2322Notes payable230Bonds payable297275Less: Discount on bonds(22)(25)Shareholders' EquityCommon Shares525495Preferred Shares750Retained earnings242227$1,227$1,074The comparative balance sheets for 2005 and 2004 and the income statement for 2005 are given below for Arduous Company. Additional information from Arduouss accounting records is also provided.30Handout #18ARDUOUS COMPANYStatement of Cash FlowFor the year ended December 31, 2005($ in millions)Cash Flow from operationsCash collected from customers$406Cash collected from investment revenue11Cash paid out to suppliers(200)Cash paid out to salaries(70)Cash paid out to insurance(3)Cash paid out on interest(21)Cash paid out on taxes(35)88Cash Flow from investingProceeds from sale of equipment$17Purchase of land(23)Purchase of investments(31)(37)Cash Flow from financingIssue of preferred shares$75Repayment of bonds(60)Cash dividends paid(22)(7)Net change in cash flow44Cash, beginning of year81Cash, end of year$125+ ($410 Sales Rev) (200 202 Decrease in A/R) (6 Accounts Written Off)Accounts ReceivableDr.Cr.2024106066406200Allowance Dbt. Accts.Dr.Cr.61088Sales RevenueWrite-off Bad DebtNew Bad Debt Estimate+ ($13 I...</p>