Chapter 22

Statement of Cash Flows

Usefulness of the Statement of Cash Flows

• The information may help users (investors, creditors, and others) assess the following:1. Liquidity and solvency – i.e. the entity’s ability to

generate future cash flows and its needs for cash resources

2. The amounts, timing, and uncertainty of future cash flows

3. The reasons why net income and net cash flow from operating activities differ

Cash and Cash Equivalents

Cash• Cash on hand• Demand deposits

Cash Equivalents• Investments that are

– Short term,– Highly liquid– Readily convertible to

known amounts of cash, and

– Subject to an insignificant risk of change in value

All references to Cash include Cash Equivalentswhen discussing the Statement of Cash Flows

IAS 7 STATEMENT OF CASH FLOWS

• Interest and dividends recognized as either operating, financing or investing activity

• Presentation must be consistent• Strong recommendation to use direct method

(exposure draft on f/s presentation requiring use of direct method-met with significant resistance)

The Cash Flow Statement

• The cash flow statement provides information about:• the cash receipts (cash inflows), and• uses of cash (cash outflows) during the year

• Inflows and outflows are reported for:• operating activities• investing activities, and• financing activities during the year

Cash Flow Classifications

1. Operating Activities-Direct Method• The cash flows resulting from the primary revenue-

producing activities of the business, such as • Collections from customers• Payments to suppliers• Payments to employees• Payments to CRA for tax

• Cash 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.)

ExampleSales Balance of $1,000,000- A/R ↑ 50,000- Deferred Revenue ↑ 100,000

Cost of Sales Balance of $600,000- A/P ↑ 100,000- Inventory ↑ 200,000

Wages Expense of $100,000

- Wages Payable ↓ 20,000

Sales $1,000,000

Increase in A/R - 50,000

Increase in Def Rev 100,000

$1,050,000

COS $(600,000)

Increase in A/P 100,000

Increase in Inv (200,000)

$(700,000)

Wages $(100,000)

Decrease in

Wages Payable (20,000)

$(120,000)

Impact on Cash Flows

Change in Cash

Change in Cash

Change in Cash

Cash Flow Classifications

2. Investing Activities• The acquisition and disposal of long term assets and

long-term investments• Examples include:

• Purchase/disposal of capital assets (tangible and intangible)

• Cash receipts from the disposal of assets mentioned above

• Cash payments to acquire equity or debt instruments• Cash receipts from the disposal of equity or debt

instruments• Cash 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 future

Cash Flow Classifications

3. Financing Activities• Changes in long-term debt or equity capital• Examples include:

• Issuing debt, or repayment of debt• Issuing new shares, or repurchase or currently

outstanding shares• Cash payments by a lessee for the reduction of the

outstanding obligation related to a finance lease• Provides information to assess potential for future

claims to entity’s cash, extent of debt and increased interest charges

Significant Noncash Transactions• Transactions that do not involve the direct receipt or

disbursement of cash in the period• Examples:

– Assets acquired by assuming debt, or issuing shares– Exchanges of non-monetary assets– Conversion of debt to equity

• Noncash transactions are not reported on the Statement of Cash Flows

• If material, they are reported as notes to the statement or in a supplementary schedule to the financial statements

Preparing a Statement of Cash Flows

• Two methods of preparing the operating cash flow section of the Statement of Cash Flows:1. Indirect method2. Direct method

• Indirect method derives operating cash flows from accrual basis income statement

• Direct method determines operating cash flows directly for each operating source or use of cash

The Statement of Cash Flows: Indirect Method

Accrual Basis Statements Cash Flow Statement

Income Statement itemsand changes in non-cash operating currentassets and current liabilities

Operating activities:Adjust net income for accruals,non-cash charges and non-operating gains/losses

Balance Sheet: Changes in Non-Current Assets

Investing activities:Inflows from sale of assets and outflows for purchases of assets

Balance Sheet:Changes in Non-CurrentLiabilities and Equity

Financing activities:Inflows and outflows from loanand equity transactions

Format 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 $ XXX

Cash flows from investing activities:(List individual inflows and outflows) $ XXNet cash flow from investing activities $ XXX

Cash flows from financing activities:(List individual inflows and outflows) $ XXNet cash flow from financing activities $ XXX

Change in cash $ XXX

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 $ XXX

Other Items

• Income 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 and

• The amount of the cash flow is the proceeds on disposal, not the gain or loss

Other Items

• Income 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 and

• The amount of the cash flow is the amount paid to redeem the debt, not the gain or loss

STATEMENT OF CASH FLOWS-COMPLEX TRANSACTIONS

• Revaluation model– Adjustments to Revaluation Surplus-OCI– Revaluation Losses– Reversal of revaluation losses

• Impairment• Investments

– FVTPL– AFS– Equity

• Investment measured at cost• Investment accounted for under equity method

• Long term debt– Current portion of ltd– Interest measured under the effective interest rate method

• Equity– Share based payments

CASH FLOW-OTHER ISSUES

CAPITAL LEASE• No recognition at inception of the lease• Subsequent payments, financing activity• Depreciation, operating cash flow

CURRENT PORTION OF LONG TERM DEBT• Not part of operating working capital

CASH FLOW-OTHER ISSUES

LONG TERM DEBT• Interest expense must be adjusted for discount/premium

amortization

SHARE BASED PAYMENT• Exercise of options increases cash flow from investing• Compensation expense related to options non-cash flow

SHARE REPURCHASE• Cash flow only relates to amount paid to obtain shares

IMPAIRMENT• Non-cash adjustment in cash flow from operations

Cash Flow per Share Information• Per CICA Handbook Section 1540, cash flow

per share should not be reported in financial statements, except if payable to owners

• IAS 7 permits the disclosure of cash flow per share

Special Items: Capital assets

Given:

2008 2007

Property, plant, and equipment $277,000 $247,000

Accumulated depreciation (178,000) ( 167,000)

Other information:

Depreciation expense $ 33,000

Gain on sale of equipment $ 14,500

During 2008, equipment costing $45,000 was sold for cash

Present relevant T- accounts and cash flow information.

Special Items: Capital assets

PP&E

247,000Beg. 45,000

Dr. Cr.

202,000

277,000End.

75,000

Cash Outflow (Investing Section)

Accum Dep.

22,000 Beg.167,000

Dr. Cr.

33,000

178,000 End.

Cash Inflow (Operations Section)

200,000

INDIRECT METHOD

Original Cost $45,000

Accumulated Depreciation (22,000)

Net Book Value 23,000

Gain on Sale 14,500

Proceeds 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.

FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

2009 2008FVTOCI $950,000 $800,000OCI 190,000 210,000

1. During the year, investments were re-measured to fair value

2. During the year, the company sold investments having a fair value of $110,000 and an original cost of $90,000 for $150,000

3. Purchased investments with a fair value of $260,000 for cash

FAIR VALUE THROUGH OTHER COMPREHENSIVE INCOME

Fair Value Through Other Comprehensive

Income

Other Comprehensive Income

Investments

Dr. Cr.Dr. Cr.

800,000

40,000

150,000

950,000

260,000

210,00040,000

190,000

60,000

Tombstone Revaluation

Dr. Fair Value Through Other Comprehensive Income 40,000

Cr. Other Comprehensive Income 40,000

(150,000 – 110,000FV)Dr. Cash 150,000

Cr. Fair Value Through Other Comprehensive Income 150,000

Dr. Other Comprehensive Income 60,000

Cr. Retained Earnings 60,000

(90,000 held @ orig. cost – 150,000 sold)

Cash Outflow (Investing Section)Acquisitions

Cash Inflow (Investing Section) Proceeds on Disposition

SHARE-BASED PAYMENT

2009 2008

Ordinary shares $1,700,000 $1,000,000

Contributed surplus-options 690,000 600,000

1. During the year, the company granted 100,000 options having a fair value of $600,000.

2. In the current year, compensation expense related to options amounting to $300,000 was recorded.

3. During the year, 30,000 options having a fair value of $150,000 were exercised for an average strike price of $12.00

4. A further $60,000 of options expired during the year.

SHARE-BASED PAYMENT

Common Shares Contributed SurplusDr. Cr. Dr. Cr.

510,0001,000,000

1,700,000

190,000

600,00060,000

690,000

150,000

Dr. Compensation Expense 300,000

Cr. Contributed Surplus – Options 300,000

Dr. Cash 360,000

Dr. Contributed Surplus – Options 150,000

Cr. Common Shares 510,000

Dr. Contributed Surplus – Options 60,000

Cr. Contributed Surplus – Expired Options 60,000

Cash Inflow (Operations Section) *Under Indirect Method Net Income includes this and must be added back since it is a non-cash item

300,000

Cash Inflow (Financing Section)

Cash Inflow (Financing Section) Issuance of Shares

INVESTMENT IN ASSOCIATE

2009 2008

Investment in Associate $650,000 $320,000

Income from Associate 300,000

1. During the year, the company purchased additional shares in the Associate for $400,000 by issuing common shares.

INVESTMENT IN ASSOCIATE

Investments in Associate

Dr. Cr.

300,000320,000

1,020,000

370,000Cash Inflow (Investing Section)

400,000

650,000

Cash 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 flow

Dr. Investment in Associate 300,000

Cr. Income from Associate 300,000

Dr. Investment in Associate 400,000

Cr. Common Shares 400,000

Dr. Cash 370,000

Cr. Investment in Associate 370,000

(to reflect dividend received from the investee)

Handout #18

Additional information from the accounting records:

a. During 2005, $6 million of customer accounts were written off as uncollectible.

b. 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.

c. The preferred shares of Tory Corporation was purchased for $25 million as a long-term investment.

d. Land costing $46 million was acquired by issuing $23 million cash and a 15-percent, four-year, $23 million note payable to the seller.

e. A building was acquired by an issue of $82 million bonds payable.

f. $60 million of bonds were retired at maturity.

g. 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 COMPANY    Income Statement    For the year ended December 31, 2005    ($ in millions)       Revenues    Sales Revenue $410    Investment Revenue 13 $423      Expenses    Cost of goods sold 180    Salaries expense 65    Depreciation expense 12    Patent amortization expense 2    Bad debt expense 8    Insurance expense 7    Bond interest expense 28    Loss on disposal of equipment due to flood 18    Income tax expense 36 356      Net Income $ 67                  

                 ARDUOUS COMPANY    Comparative Balance Sheets    December 31, 2005 and 2004 ($ in millions)       Assets 2005 2004   Cash $125 $81   Accounts receivable 200 202   Less: Allowance for doubtful accounts (10) (8)   Investment revenue receivable 6 4   Inventory 205 200   Prepaid insurance 4 8   Long-term investment 156 125   Land 196 150   Buildings and equipment 412 400   Less: Accumulated depreciation (97) (120)   Patent 30 32   $1,227 $1,074   Liabilities    Accounts payable $50 $65   Salaries payable 6 11   Bond interest payable 8 4   Income tax payable 23 22   Notes payable 23 0   Bonds payable 297 275   Less: Discount on bonds (22) (25)      Shareholders' Equity    Common Shares 525 495   Preferred Shares 75 0   Retained earnings 242 227   $1,227 $1,074                   

The comparative balance sheets for 2005 and 2004 and the income statement for 2005 are given below for Arduous Company. Additional information from Arduous’s accounting records is also provided.

Handout #18                 ARDUOUS COMPANY    Statement of Cash Flow    For the year ended December 31, 2005    ($ in millions)       Cash Flow from operations    Cash collected from customers $406   Cash collected from investment revenue 11   Cash 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)   88   Cash Flow from investing    Proceeds from sale of equipment $17   Purchase of land (23)   Purchase of investments (31)   (37)   Cash Flow from financing    Issue of preferred shares $75   Repayment of bonds (60)   Cash dividends paid (22)   (7) 

  Net change in cash flow 44   Cash, beginning of year 81   Cash, end of year $125                

+ ($410 Sales Rev) – (200 – 202 Decrease in A/R) – (6 Accounts Written Off)

Accounts ReceivableDr. Cr.

202

410

606

6

406

200

Allowance Dbt. Accts.Dr. Cr.

6

10

8

8Sales Revenue

Write-off Bad DebtNew Bad Debt Estimate

+ ($13 Investment Rev) – (6 – 4 Increase Investment Revenue Receivable)

– ($180 COGS) – (205 – 200 Increase Inventory) + (50 – 65 Decrease in A/P)

– ($65 Salaries Exp.) + (6 – 11 Decrease Salaries Payable)

– ($7 Insurance Exp.) – (4 – 8 Decrease Prepaid Insurance)

– ($28 Bond Interest Exp.) + (8 – 4 Increase Bond Interest Payable) + (-22 – -25 Discount on Bonds)

– ($36 Income Tax Exp.) + (23 – 22 Increase Income Tax Payable)

Sold machine due to flood for this amount

$46 million cost land paid 23 cash, rest non-cash note payable

– ($156 – 125 increase in long-term investment)

+ ($75 – 0 Increase in Preferred Shares)

$60 million bonds retired at maturity

($227 beg. R/E) + (67 Net Income) – (7.54 Stock Div.) = 264 R/E available to pay in dividends after non-cash dividends declared out

$242 end. R/E – 264 = (22) Dividends paid in cash (cash outflow)

Retained EarningsDr. Cr.

30

294

227

67

264

242

22 Net Income($7.504 million) Stock Dividend

Cash Outflow (cash dividend paid)

Handout #18                 ARDUOUS COMPANY    Statement of Cash Flow    For the year ended December 31, 2005    ($ in millions)       Cash Flow from operations    Net Income $67   Adjust for non cash items    Depreciation 12   Patent amortization 2   Amortization of discount on bonds payable 3   Loss on disposal of equipment 18   Changes in working capital    Decrease in A/R - net 4   Increase in investment revenue receivable (2)   Increase in inventory (5)   Decrease in prepaid insurance 4   Decrease in accounts payable (15)   Decrease in salaries payable (5)   Increase in bonds interest payable 4   Increase in income taxes payable 1   88 

+ (-22 – -25 Discount on Bonds)

+ (6 Accounts Written Off i.e. non-cash income statement exp. added back) + (200 – 202 Decrease in A/R i.e. included in the write-off amount so must exclude this as part of the difference due to the write-off.)

– (6 – 4 Increase Investment Revenue Receivable)

– (205 – 200 Increase Inventory)

– (4 – 8 Decrease Prepaid Insurance)

+ (50 – 65 Decrease in A/P)

+ (6 – 11 Decrease Salaries Payable)+ (8 – 4 Increase Bond Interest Payable)

+ (23 – 22 Increase Income Tax Payable)

Handout #19

Additional information from the accounting records:

a. Included in the general expenses is stock based compensation that amounts to $220,000. During the year, 10,000 options with a fair value at issuance $6 were exercised for $22 per share.

b. During the current year, equipment having a cost of $300,000 was sold. The equipment had a net book value of $180,000.

c. At December 31, the company leased an asset for $500,000 with the first payment due at the inception of the lease.

d. Included in the interest expense is amortization of a debt premium of $30,000.

e. Land having a value of $300,000 was acquired in exchange of common shares having a value of $500,000.

f. During the year, land currently measured at fair value was revalued. Prior year losses of $80,000 were charged to general expense.

g. Dividends of $220,000 were declared during the year.

Required:

Prepare the cash flow statement of Jay-z CORP. for the year ended December 31, 2008 using the indirect method. Present cash flows from operating activities by the direct method.

The comparative balance sheets for 2008 and 2007 and the income statement for 2008 are given below for Jay-z CORP. Additional information from Jay-z’s accounting records is also provided.

  Jay-z CORP.    Income Statement    For the year ended December 31, 2008    ($ in millions)       Revenues    Sales Revenue $3,678,000      Expenses    Cost of goods sold 1,216,000   Salaries expense 250,000   Administrative expense 325,000   General expense 650,000   Depreciation expense 490,000   Impairment 160,000   Fair value loss 5,000   Interest expense 90,000   Equity earnings of associate (300,000)   Gain on disposal of equipment (70,000)   Income tax expense 180,000      Net Income $682,000            

  Jay-z CORP.    Comparative Balance Sheets    December 31, 2008 and 2007 ($ in millions)       Assets 2008 2007   Cash $300,000 $200,000   Accounts receivable 470,000 325,000   Investments, Fair Value Through Profit and Loss 157,000 162,000   Inventory 821,900 398,250   Land 550,000 200,000   Buildings 850,000 750,000   Less: Accumulated amortization (420,000) (320,000)   Equipment 950,000 600,000   Less: Accumulated amortization (650,000) (380,000)   Leased assets 500,000    Goowill 90,000 250,000   Investments, Available for Sale 560,000 380,000   Investment in Associate 580,000 300,000   $4,758,900 $2,865,250   Liabilities    Accounts payable $320,000 $200,000   Income taxes payable 260,000 215,000   Dividends payable 120,000 90,000   Current portion of bond payable 620,000 420,000   Current portion of leased asset 98,000    Deferred revenue 420,000 180,000   Bond payable 840,000 1,220,000   Leased assets 304,000       Shareholders' Equity    Ordinary shares 774,650 340,000   Other comprehensive income 60,000 (120,000)   Contributed surplus-options 320,000 160,000   Retained earnings 622,250 160,250   $4,758,900 $2,865,250 

Handout #19  Jay-z CORP.    Statement of Cash Flow    For the year ended December 31, 2008    ($ in millions)       Cash Flow from operations    Net Income $682,000   Adjust for non cash items    Depreciation 490,000   Impairment 160,000   Fair value loss 5,000   Equity earnings (300,000)   Gain on Disposal (70,000)   Stock based compensation 220,000   Premium amortization (30,000)   Revaluation recovery (50,000)   Changes in working capital    Accounts receivable (145,000)   Inventory (423,650)   Accounts payable 120,000   Income taxes payable 45,000   Deferred revenue 240,000   943,350   Cash Flow from investing    Building addition $(100,000)   Proceeds from equipment 250,000   Purchase of equipment (650,000)   Dividends from associate 20,000   (480,000)   Cash Flow from financing    Shares issued on exercise of options $220,000   Lease payment (98,000)   Debt payment (150,000)   Share repurchase (145,350)   Dividends (190,000)   (363,350) 

  Net change in cash flow 100,000   Cash, beginning of year 200,000   Cash, end of year $300,000                

Add back stock-based compensation (non-cash exp.)

Exclude premium amortization which reduced int. exp. so cash outflow to add back to income

Exclude ($550,000 ending bal. Land) – (200,000 Land Beg. + 300,000 Acquired with shares ) this is a non-cash so reverse the revaluation gain back from net income, or cash outflow.

– ($850,000 – 750,000 Increase in Buildings)

+ ($180,000 Equipment NBV) + (70,000 Gain on disposal)600,000 Beg. Bal. – 300,000 Equip. Sold (@cost on the books) = 300,000 in Equip.– ($950,000 End. Bal. – 300,000 in Equip. after disposal) = (650,000)

+ 10,000 options$22 per share+ (304,000 Long-term portion of lease + 98,000 Current portion) – ($500,000 Leased Asset)

(420,000+1,220,000 Total Debt FY2008) – (30,000 Amortization of debt premium) = 1,610,000+ (620,000+840,000 Total Debt FY2009) – 1,610,000 = (150,000) Debt payment

(340,000 C/S FY2008) + (300,000 shares issued in exchange for land) + ({$22 per share10,000 options}+{[160,000 Cont. Surplus-options beg. + 220,000 stock compensation exp.] – 320,000 Cont. Surplus-options ending} ) = 920,000 ► (774,650 C/S FY2009) – 920,000 = (145,350) Share repurchases

+ ($300,000 equity earnings in associate) – (580,000 – 300,000 Increase in Investment in Associate)

Dividends PayableDr. Cr.

90,000

Retained EarningsDr. Cr.

160,250

220,000

220,000Dividends Declared

Dividends expense includes payable310,000

120,000

682,000 Net Income622,250190,000

Dividends Actually Paid out (Cash Outflow)

Dr. Land 300,000

Cr. Common Shares 300,000

Handout #19

                 Jay-z CORP.    Statement of Cash Flow    For the year ended December 31, 2008    ($ in millions)       Cash Flow from operations    Cash collected from customers $3,773,000   Cash paid to suppliers (1,519,650)   Cash paid for operating expenses (1,055,000)*   Cash paid out on interest (120,000)   Cash paid out on taxes (135,000)   943,350 

  *Operating expenses    Includes compensation expense options of 220,000    Includes Revaluation gain of 50,000  

+ ($3,678,000 Sales Revenue) – (470,000 – 325,000 Increase in A/R) + (420,000 – 180,000 Increase Deferred Revenue)

– ($1,216,000 COGS) – (821,900 – 398,250 Increase in Inventory) + (320,000 – 200,000 Increase in A/P)

– ($250,000 Selling) – (325,000 Administrative) – (650,000 General – 220,000 Stock based compensation included in general expenses that should be excluded since it is non-cash + 50,000 Land Revaluation Gain included in general exp.)

– ($90,000 Interest Exp. + 30,000 Amortization of debt premium)Since the debt premium is a credit, it reduced interest paid of 120,000 down to 90,000 since it was included in interest expense. In using the interest expense, add back the debt premium to find cash flow impact of interest.

– ($180,000 Income Tax Exp.) + (260,000 – 215,000 Increase in Income Taxes Payable)

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