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Chapter 13 “How Well Am I Doing?” Statement of Cash Flows 13- 2 Purpose of the Statement of Cash Flows Why is there a difference between net income and net cash flow? Are cash flows sufficient to support ongoing operations? Can we meet our obligations to creditors?

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Chapter 13 l.jpg

Chapter 13

“How Well Am I Doing?” Statement of Cash Flows


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13-2

Purpose of the Statement of Cash Flows

Why is there a difference between net income and net cash flow?

Are cash flows sufficient to support ongoing operations?

Can we meet our obligations to creditors?

Will the company have to borrow money to make needed investments?

Can we pay dividends?


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13-3

Learning Objective 1

Classify changes in noncash balance sheet accounts as sources or uses of cash.


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The term cash on the statement of cash flows refers broadly to both currency and cash equivalents.

13-4

Definition of Cash

Currency and Bank Accounts

Treasury Bills

Cash

Commercial Paper

Money Market Funds


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13-5

4. Changes in Capital Stock

3. Changes in Liabilities

5. Dividends Paid to Stockholders

2. Changes in Noncash Assets

1. Net Income

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Net Cash Flows for a Period


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13-6

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts


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13-7

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Increases in noncash assetaccounts imply uses of cash.

Example: Inventory is purchased on credit from a supplier.

It is implied that cash was used to acquire the inventory.


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13-8

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Increases in liability accounts imply sourcesof cash.

Example: Inventory is purchased on credit from a supplier.

It is implied that an increase in a payable has the effect of increasing cash available for other uses.


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13-9

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Decreases in noncash assetsaccounts imply sourcesof cash.

Example: Accounts receivable decreases when a company pays its bill.

The company’s cash increases accordingly.


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13-10

Constructing the Statement of Cash Flows Using Changes in Noncash Balance Sheet Accounts

Decreases in liabilityaccounts imply uses of cash.

Example: If a company makes a payment on a note payable.

The company’s cash balance decreases accordingly.


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13-11

A Simplified Statement of Cash Flows


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13-12

A Simplified Statement of Cash Flows

Additional Information:

  • There was a net loss for the year of $27,000.

  • Depreciation charges for the year were $6,000.

  • During the year, Ed sold land originally costing $32,000 for $32,000.

  • During the year, Ed purchased equipment for $28,000.

  • During the year, Ed paid dividends of $3,000 to the stockholders.

  • Ed issued $50,000 of common stock to settle the note due to Joe Doe.


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13-13

A Simplified Statement of Cash Flows

Here is a summary of the sources of cash for Ed’s Pizza Hut.


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13-14

A Simplified Statement of Cash Flows

Here is a summary of the uses of cash.

The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.


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13-15

A Simplified Statement of Cash Flows

This simplified approach does not follow the format required for external reporting purposes. It is for illustrative purposes only.


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13-16

Learning Objective 2

Classify transactions as operating, investing, or financing activities.


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13-17

The Three Sections of the Statement of Cash Flows

Operating activities are those activities that enter into the determination of net income.

1. Transactions affecting current assets

3. Changes in noncurrent balance sheet accounts that directly affect net income

2. Transactions affecting current liabilities


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13-18

The Three Sections of the Statement of Cash Flows

Investing activities relate to transactions involving the acquiring or disposing of noncurrent assets.

1. Acquiring or selling property, plant and equipment

3. Lending money to another entity and subsequently collecting on the loan

2. Acquiring or selling securities held for long-term investments


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13-19

The Three Sections of the Statement of Cash Flows

Financing activities relate to transactions involving borrowing from creditors or repaying creditors and engaging in transactions with the company’s owners.

1. Issuing stock and purchasing treasury stock

3. Payment of dividends (note that interest on debt is classified as an operating activity)

2. Issuing long-term debt and repayment of debt


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13-20

Format of the Statement of Cash Flows (Indirect Method)


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13-21

Format of the Statement of Cash Flows (Indirect Method)

Operating Activities

Reconciliation of the beginning cash balance with the ending cash balance

Investing Activities

Financing Activities

Noncash Investing and Financing Activities


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13-22

Operating Activities

Includes those activities that affect current assets, current liabilities, or net income.


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13-23

Operating Activities

Sources of cash are added to and uses of cash are subtracted from net cash provided by operating activities.


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13-24

Operating Activities


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13-25

Operating Activities


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13-26

Operating Activities

Depreciation and Amortization charges are added back because they are decreases in noncash assets.


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13-27

Operating Activities

Gains are subtracted.

Losses are added.


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13-28

Investing Activities

Includes transactions that involve the acquisition or disposal of noncurrent assets.


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13-29

Financing Activities

Includes transactions involving receipts from or payments to creditors and owners.


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For investing and financing activities, items on the statement of cash flows should be presented in gross amounts rather than in net amounts.

Example:

Assume Macy’s purchases $50 million in property during the year and sells other property for $30 million.

Instead of showing the net change of $20 million, the company must report the gross amounts of both transactions.

13-30

Cash Flows: Gross or Net?


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.31

Direct Method

Indirect Method

Reports the cash effects of each operating activity

Starts with accrual net income and adjusts it to the cash basis

Operating Activities: Direct or Indirect Method?

Two Formats for Reporting Operating Activities

No matter which format is used, the same amount of net cash provided by operating activities is generated.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.32

Learning Objective 3

Prepare a statement of cash flows using the indirect method to determine the net cash provided by operating activities.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.33

Statement of Cash Flows: Indirect Method

Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.34

Statement of Cash Flows: Indirect Method

Refresh your memory regarding the following additional information.

  • There was a net loss for the year of $27,000.

  • Depreciation charges for the year were $6,000.

  • During the year, Ed sold land originally costing $32,000 for $32,000.

  • During the year, Ed purchased equipment for $28,000.

  • During the year, Ed paid dividends of $3,000 to the stockholders.

  • Ed issued $50,000 of common stock to settle the note due to Joe Doe.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.35

Step 1 of 8

List each account appearing on the comparative balance sheets except for cash and cash equivalents and retained earnings.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.36

Step 2 of 8

Compute the change from the beginning balance to the ending balance for each account.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.37

{

Recall that the transaction involving the Notes Payable and Common Stock was noncash.

Step 3 of 8

Code each entry on the worksheet as a source or use of cash.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.38

Step 4 of 8

Code sources of cash as positive numbers and uses of cash as negative numbers.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.39

{

We need to make an adjustment for the noncash transaction relating to Notes Payable and Common Stock.

Step 5 of 8

Make any necessary adjustments, including adjustments for gains and losses. The net effect of these should equal zero.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.40

Step 6 of 8

Classify each entry as operating, investing, or financing activity.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.41

Step 7 of 8

Copy the data from the worksheet into the Statement of Cash Flows section by section.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.42

Step 8 of 8

Prepare a cash reconciliation at the bottom of the statement.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.43

Statement of Cash Flows: Indirect Method

In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity.


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Examine the operating activities section carefully. statement of cash flows should be presented in gross amounts rather than in net amounts.

Ed’s Pizza Hut generated a negative net cash provided by operating activities of $20,000. This is usually a sign of fundamental difficulties.

Ultimately, a positive cash flow is necessary to avoid liquidating assets or borrowing money to pay for day-to-day activities.

13-44

Interpretation of the Statement of Cash Flows


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.45

Learning Objective 4

Compute free cash flow.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.46

Free Cash Flow

Free cash flow measures a company’s ability to fund its capital expenditures and dividends from its net cash provided by operating activities.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.47

Free Cash Flow

Using the equation shown on the prior slide, the free cash flow for Ed’s Pizza Hut of ($51,000) is computed like this . . .


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Appendix 13A statement of cash flows should be presented in gross amounts rather than in net amounts.

The Direct Method of Determining the Net Cash Provided by Operating Activities.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.49

Learning Objective 5

Use the direct method to determine the net cash provided by operating activities.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.50

Computing Net Cash Provided by Operating Activities

The direct method computes net cash provided by operating activities by reconstructing the income statement on the cash basis from top to bottom.

However

The amount of net cash provided by operating activities under the direct method will always agree with the amount computed using the indirect method.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.51

Similarities and Differencesin Handling Data

Adjustments for accounts that affect revenue are the same in the direct method and indirect methods.

Adjustments for accounts that affect expenses are handled in opposite ways for the direct and indirect methods.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.52

Direct Method: Gains and Losses

Regarding gains and losses on sale of assets, no adjustments are needed at all under the direct method.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.53

The Direct Method

Let’s revisit the comparative balance sheet account balances for Ed’s Pizza Hut.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.54

The Direct Method

Let’s assume that Ed’s Pizza Hut prepared this income statement.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.55

The Direct Method

Step 1: Translate sales revenue into cash collected from customers.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.56

The Direct Method

Step 2: Translate cost of goods sold into cash disbursements for purchases.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.57

The Direct Method

Step 3: Translate operating expenses into cash paid for operating expenses.

There is not an adjustment needed for income taxes because Ed’s Pizza Hut has a net loss of $27,000.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.58

The Direct Method

Notice that the net cash provided by operating activities agrees with that computed using the indirect method.


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Appendix 13B statement of cash flows should be presented in gross amounts rather than in net amounts.

The T-Account Approach to Preparing the Statement of Cash Flows


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.60

T-Account Approach: Statement of Cash Flows


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.61

T-Account Approach: Statement of Cash Flows

Additional Information:

  • There was a net loss for the year of $27,000.

  • Depreciation charges for the year were $6,000.

  • During the year, Ed sold land originally costing $32,000 for $32,000.

  • During the year, Ed purchased equipment for $28,000.

  • During the year, Ed paid dividends of $3,000 to the stockholders.

  • Ed issued $50,000 of common stock to settle the note due to Joe Doe.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.62

T-Account Approach

Here is a summary of the sources of cash for Ed’s Pizza Hut.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.63

T-Account Approach

Here is a summary of the uses of cash for Ed’s Pizza Hut.

The net cash flow for Ed’s Pizza Hut is ($19,000): $66,000 in sources minus $85,000 in uses.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.64

T- Account Approach


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.65

T-Account Approach


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.66

T-Account Approach


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.67

T-Account Approach


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.68

T-Account Approach


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.69

No Effect in the Cash Account.

T-Account Approach

What about the $50,000 issuance of common stock to settle the note payable to Joe Doe?

However, this transactions would be disclosed in a supplemental schedule that accompanies the statement of cash flows.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.70

T-Account Approach

The net effect of these transactions on the cash account is as shown.

Notice, the net decrease in cash is $19,000.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.71

The Statement of Cash Flows

In addition, on the face of the statement or in a supplemental schedule, disclose the issuance of $50,000 of stock to a creditor, a noncash financing activity.


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13- statement of cash flows should be presented in gross amounts rather than in net amounts.72

End of Chapter 13


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