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Chapter Twelve Statement of Cash Flows Reporting Format for the Statement of Cash Flows The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95 : Operating Activities Investing Activities Financing Activities Inflows Receipts from sales.

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chapter twelve

Chapter Twelve

Statement ofCash Flows

reporting format for the statement of cash flows
Reporting Format for the Statement of Cash Flows

The Statement of Cash Flows must include the following three sections, as defined in FASB Statement 95:

Operating Activities

Investing Activities

Financing Activities

cash flows from operating activities

Inflows

  • Receipts from sales.
  • Commissions and fees.
  • Interest and dividends received.

Outflows

  • Payments for inventory.
  • Salaries and wages.
  • Operating expenses
  • Interest on liabilities.
  • Taxes.
Cash Flows from Operating Activities

Cash Flows from Operating Activities

cash flows from investing activities
Inflows

Selling property, plant, and equipment.

Selling investment securities.

Collecting loans.

Outflows

  • Purchasing property, plant, and equipment.
  • Purchasing investment securities.
  • Lending to others.
Cash Flows from InvestingActivities

Cash Flows from Investing Activities

cash flows from financing activities
Inflows

Borrowing.

Issuing stock.

Outflows

  • Repaying debt (excluding interest).
  • Purchasing treasury stock.
  • Paying dividends.
Cash Flows from Financing Activities

Cash Flows from Financing Activities

noncash investing and financing transactions
Noncash Investing and Financing Transactions
  • Significant noncash investing and financing transactions must be reported separately.
  • Example: issuing common stock in exchange for land.
slide8

Cash Flows from Operating Activities

Cash flows from operating activities can be prepared using either the direct method or the indirect method.

Let’s look at the direct methodfirst.

converting from accrual to cash basis accounting
Accrual basis revenue includes sales that did not result in cash inflows.

Cash received from customers can be computed as follows:

Converting from Accrual to Cash-Basis Accounting

Decrease in receivables

+

=

Cash received from customers

Net sales

Increase in receivables

=

converting from accrual to cash basis accounting10
Converting from Accrual to Cash-Basis Accounting

We will use T-accounts toanalyze changes in accounts.

Let’s look at an example.

The Accounts Receivable balance was $27,000 on 12/31/04 and $35,000 on 12/31/05. If accrual Sales Revenue for 2005 was $800,000, what were cash receipts from sales?

converting from accrual to cash basis accounting11

$27,000 + $800,000 - $35,000

Converting from Accrual to Cash-Basis Accounting

Accounts Receivable

12/31/04 Balance

Cash receipts =

Accrual Sales Revenue

$792,000

12/31/05 Balance

The Accounts Receivable balance was $27,000 on 12/31/04 and $35,000 on 12/31/05. If accrual Sales Revenue for 2005 was $800,000, what were cash receipts from sales?

converting from accrual to cash basis accounting12
Converting from Accrual to Cash-Basis Accounting

Now let’s use T-account analysis for a liability account with anaccrued expense.

The Salaries Payable balance was $7,000 on 12/31/04 and $5,000 on 12/31/05. If accrued Salaries Expense for 2005 was $80,000, what amount of cash was paid for salaries?

converting from accrual to cash basis accounting13

$7,000 + $80,000 - $5,000

Converting from Accrual to Cash-Basis Accounting

Salaries Payable

12/31/04 Balance

Accrued Salaries Expense

Cash payments =

$82,000

12/31/05 Balance

The Salaries Payable balance was $7,000 on 12/31/04 and $5,000 on 12/31/05. If accrual Salaries Expense for 2005 was $80,000, what amount of cash was paid for salaries?

slide14

Direct Method

Now that we have seen the T-account method of analysis, let’s use it to prepare a Direct MethodStatement of Cash Flows for Batson Company.

We will begin with by analyzing changes in balance sheet accounts.

direct method
Direct Method

Additional Information

  • Depreciation on buildings was $6,000 in 2005. Depreciation on equipment was $4,000 in 2005.
  • A building addition in 2005 cost $31,000, paid in cash.
  • Equipment with a book value of $40,000 was sold during the year for $43,000.
  • Equipment with a book value of $30,000 was destroyed during a flood in 2005. There was no insurance.
  • Batson had no noncash financing and investing activities.
direct method19
Direct Method

Additional Information

  • Batson’s tax rate is 40%.
  • Interest Expense on Notes Payable was $6,500.
  • Interest Expense on Bonds Payable was $18,000.
  • Issued Common Stock during 2005 for $50,000.
  • Other Expenses of $71,000 were paid in cash.

Let’s get started analyzing the accounts. First, we willreview the T-account analysis that we completed earlier.Then we will analyze the remaining balance sheet accounts starting with the current accounts.

slide20

Accounts Receivable

12/31/04 Balance

Cash receipts = $792,000

Accrual sales revenue

12/31/05 Balance

Salaries Payable

12/31/04 Balance

Accrued salaries expense

Cash Payments = $82,000

12/31/05 Balance

slide21

Accounts Payable

12/31/04 Balance

Purchases

Cash Payments =

12/31/05 Balance

Inventory

12/31/04 Balance

Cost of Goods Sold

Purchases =

$430,000

12/31/05 Balance

$433,000

slide22

Income Taxes Payable

12/31/04 Balance

Income Tax Expense

Cash payment =

12/31/05 Balance

Interest Payable

12/31/04 Balance

Interest Expense

Cash payments =

$22,000

12/31/05 Balance

$54,000

slide23

Direct Method

Now, that we have analyzed the current accounts and found the cash receipts and cash payments related to operations, we are ready to prepare the Cash Flows from Operating Activities portion of the Statement of Cash Flows.

slide25

Direct Method

Now, Let’s continue to use the T-account analysis for the remaining noncurrent balance sheet accounts.

slide26

Equipment, Net

Equipment sale

12/31/04 Balance

Flood loss

Depreciation

12/31/05 Balance

Buildings, Net

12/31/04 Balance

Cash paid for addition =

$31,000

Depreciation

12/31/05 Balance

slide27

Land

12/31/04 Balance

Cash paid for land purchase =

$72,000

12/31/05 Balance

After completing the analysis of noncurrent assets,we are ready to prepare the Cash Flow fromInvesting portion of the Statement of Cash flows.

cash flow from investing activities
Cash Flow from Investing Activities

Next, we will analyze noncurrent liabilities and equity so that we can prepare the Cash Flow from Financing portion of the Statement of Cash flows.

slide29

Bonds Payable

12/31/04 Balance

Cash paid to retire bonds =

12/31/05 Balance

Notes Payable

12/31/04 Balance

Cash paid to retire notes =

$10,000

12/31/05 Balance

$100,000

slide30

Common Stock

12/31/04 Balance

Cash received from stocksale =

$50,000

12/31/05 Balance

After completing the analysis of noncurrent liabilitiesand equity, we are ready to prepare the Cash Flowfrom Financing portion of the Statement of Cash flows.

cash flow from financing activities
Cash Flow from Financing Activities

Next, we will put the three sections together to completethe Statement of Cash Flows.

slide32

Notice that the Ending Cash Balance on the Statement of Cash Flows agrees with the 12/31/05 Cash balance on the Balance Sheet.

slide33

Indirect Method

Now let’s look at theIndirect Methodthat is used by over 95% of all companies.

a comparison of the direct and indirect methods
A Comparison of the Direct and Indirect Methods
  • Net cash flow is the same for both methods.
  • The Direct Method provides more detail about cash from operating activities.
  • The investing and financing sections for the two methods are identical.
indirect method
Indirect Method

Changes in current assets and current liabilities as shown on the following table.

Cash Flows from Operating Activities

Net Income

+ Losses and - Gains

+ Noncash expenses such as depreciation and amortization.

indirect method36
Indirect Method

Use this table when adjusting Net Incometo Cash Flow form Operations.

indirect method37
Indirect Method

We will use the Indirect Methodto prepare the Cash Flows from Operating Activities for the Batson Company.

First, we will review the Balance Sheet and Income Statement for Batson Company.

slide41

The Indirect Method begins with Net Income, which is then adjusted for the non-cash items included in net income.

For Batson, the only non-cash items are depreciation, and gains and losses.

slide42

To complete the Cash flows from operating activities section, we must examine comparative balance sheets to determine the changes in current assets and current liabilities from the beginning of the period to the end of the period.

(Remember, we showed the balance sheets a few slides earlier.)

slide44

Remember that when we prepared the operating section using the Direct Method, we also arrived at Net Cash flows from Operating Activities of $130,000.

indirect method45
Indirect Method

Because the investingand financing sectionsare identical with eithermethod of preparation, we will not repeatthose sections of thestatement.

the financial analyst

Ability to generate cashfrom its operations.

Management of currentassets and current liabilities.

Expenditures forlong-term assets.

Amount received fromexternal financing.

The Financial Analyst

The statement focusesattention on: