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Fundamental Financial Accounting Concepts Fourth Edition by Edmonds, McNair, Milam, Olds PowerPoint ® presentation by J. Lawrence Bergin Chapter 12 Statement of Cash Flows Purpose of the Statement of Cash Flows To show how the business acquired its cash during the current year

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fundamental financial accounting concepts fourth edition by edmonds mcnair milam olds
Fundamental Financial Accounting ConceptsFourth EditionbyEdmonds, McNair, Milam, Olds

PowerPoint® presentation by

J. Lawrence Bergin

chapter 12
Chapter 12

Statement of Cash Flows

purpose of the statement of cash flows
Purpose of the Statement of Cash Flows
  • To show how the business acquired its cash during the current year
  • To show how the business spent its cash during the current year

This information is crucial for decision makers to predict future cash flows of the business.

what is considered cash for the statement of cash flows
What is considered “CASH” for the Statement of Cash Flows?
  • Cash includes cash and cash equivalents for purpose of the statement.
  • Cash Equivalents are
    • Short-term, highly liquid investments, with
    • Maturity dates of 3 months or less from the date acquired by the holder, and are
    • Easily convertible into known amounts of cash.
categories of cash flows
Categories of Cash Flows
  • They are based on activities
  • related to cash flows:
  • Operating the business.
  • Investing in productive assets.
  • Financing the business.
  • These are the sections of the Statement of Cash Flows.
operating activities
Operating Activities
  • Cash inflows and outflows that are directly related to income from normal operations.
  • Technically, FASB defines operating activities as those that are not investing or financing activities.
  • There are two ways to compute net cash flow from operating activities:
    • Direct method
    • Indirect method
cash flows from operating activities
Cash Flows from Operating Activities
  • Cash inflows and outflows that are directly related to income from normal operations.
  • Inflows include:
    • Receipts from customers.
    • Interest on receivables.
    • Dividends received.
cash flows from operating activities8
Cash Flows from Operating Activities
  • Cash inflows and outflows that are directly related to income from normal operations.
  • Outflows include:
    • Payments to suppliers.
    • Interest paid on liabilities.
    • Income taxes paid.
    • Salary and wages payments to employees.

Pay to the order of

cash flows from investing activities
Cash Flows from Investing Activities
  • Cash inflows and outflows that are related to the purchase and sale of productive assets.
  • Inflows include proceeds from:
    • Sales of property, plant, and equipment.
    • Sales of investments in securities.
    • Collection of principal on loans made to others.
cash flows from investing activities10
Cash Flows from Investing Activities
  • Cash inflows and outflows that are related to the purchase and sale of productive assets.
  • Outflows include payments for:
    • The purchase of property, plant and equipment.
    • The purchase of long-term investments.
    • Loans to others.
cash flows from financing activities
Cash Flows from Financing Activities
  • Cash inflows and outflows that are related to how cash was obtained to finance the enterprise.
  • Inflows include:
    • Proceeds from sale of stock.
    • Proceeds from sale of bonds and from borrowings.
cash flows from financing activities12
Cash Flows from Financing Activities
  • Cash inflows and outflows that are related to how cash was obtained to finance the enterprise.
  • Outflows include:
    • Payments to purchase treasury stock.
    • Principal payments to retire bonds and loans.
    • Dividends paid to owners.

(Remember, INTEREST paid is NOT a financing activity; it is an Operating Activity.)

cash flows from noncash activities
Cash Flows from Noncash Activities
  • Investing and financing activities that do not involve cash, e.g.,
    • Retirement of bonds by issuing stock.
    • Settlement of debt by transferring assets other than cash.
  • Noncash activities must be disclosed separately in the financial statements.
preparing the statement of cash flows
Preparing the Statement of Cash Flows

The face of the statement includes:

Net Cash Flows from Operating Activities

+Net Cash Flows from Investing Activities

+Net Cash Flows from Financing Activities

=Net change in Cash Flows for the period

+ Beginning Cash Balance

=End of period Cash Balance

two alternative approaches
Two Alternative Approaches
  • Indirect Method
    • Shows net cash inflow (outflow) from operations as an adjustment of net income.
    • Used by 97% of companies.
  • Direct Method (used in Ch. 1-11 in text.)
    • Reports the components of cash from operations as gross receipts and payments.
    • Recommended by the FASB, but rarely used.
converting accrual data to cash data
Converting Accrual Data to Cash Data
  • Accounting records are kept on the accrual basis (GAAP).
  • Cash data must be developed before the SCF can be prepared (especially for operating activities).
  • The examples that follow demonstrate the direct method for converting accrual data to cash data.
three information sources are used
Three information sources are used:
  • The income statement for the current period.
  • Comparative beginning of period and end of period balance sheets.
  • Additional transaction details not found in the financial statements.
direct method scf converting revenues to cash basis
Direct Method SCFConverting Revenues to Cash Basis
  • Accrual basis revenue includes sales that did not result in cash inflows.
  • Can be computed as:

+ decreaseor

- increase

in A/R

Revenue,

Accrual basis

Revenue,

Cash basis

=

direct method scf example
Direct Method SCFExample:

The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue?

direct method scf example20
Direct Method SCFExample:

The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue?

Accounts Receivable

45,000

52,000

direct method scf example21
Direct Method SCFExample:

The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue?

Accounts Receivable

45,000

Cash

collected

600,000

52,000

direct method scf example22
Direct Method SCFExample:

The A/R balance was $45,000 on 1/1/04 and $52,000 on 12/31/04. If accrual sales revenue for 2004 was $600,000, what was cash basis revenue?

So,

Accrual Sales $600,000

- Increase in A/R 7,000

= Cash collected

from customers $593,000

Accounts Receivable

45,000

593,000

Cash

collected

600,000

52,000

direct method converting accrued expenses to cash
Direct Method Converting Accrued Expenses to Cash
  • Accrual basis expenses include expenses that have not yet been paid.
  • Can be computed as:

Expense,

Accrual Basis

+ decrease

or

- increase in

“expense” payables

Expense,

Cash Basis

direct method scf example24
Direct Method SCFExample:

(Accrued) Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

direct method scf example25
Direct Method SCFExample:

Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

Salary Payable

Salary Expense

direct method scf example26
Direct Method SCFExample:

Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

Salary Payable

Salary Expense

$500,000

direct method scf example27
Direct Method SCFExample:

Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

Salary Payable

Salary Expense

35,000

$500,000

10,000

direct method scf example28
Direct Method SCFExample:

Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

Salary Payable

Salary Expense

35,000

$500,000

$500,000

10,000

direct method scf example29
Direct Method SCFExample:

Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

Salary Payable

Salary Expense

35,000

$500,000

525,000

$500,000

10,000

direct method scf example30
Direct Method SCFExample:

Salary Expense for 2004 was $500,000. Salary Payable was $35,000 on 12/31/04 and $10,000 on 12/31/04. How much cash was paid to employees in 2004?

So,

Accrual exp. $500,000

+ Decr. in pay. 25,000

= Cash paid $525,000

Salary Expense

Salary Payable

35,000

$500,000

525,000

Cash paid

$500,000

10,000

direct method converting cost of goods sold to cash basis
Direct MethodConverting Cost of Goods Sold to Cash Basis
  • Requires analysis of two balance sheet accounts: inventoryand accounts payable.
  • Can be computed as:

+ Increase or - Decrease in inventory

and

+ Decrease or - Increase in accounts payable

Cost of Goods Sold Expense

Cash payments

to suppliers

slide32

Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

20,000

12,000

10,000

Accounts Payable

13,000

13,600

slide33

Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

20,000

12,000

10,000

Accounts Payable

13,000

13,600

What increases and decreases each account?

slide34

Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

Purchases

on credit

Inv. sold

20,000

12,000

10,000

Accounts Payable

Purchases

on credit

13,000

13,600

slide35

Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

Purchases

on credit

Inv. sold

20,000

12,000

10,000

Accounts Payable

Cash paid to suppliers

Purchases

on credit

13,000

13,600

slide36

Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

Purchases

on credit

Inv. sold

20,000

12,000

20,000

10,000

Accounts Payable

Cash paid to suppliers

Purchases

on credit

13,000

13,600

slide37

Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

Purchases

on credit

Inv. sold

20,000

12,000

20,000

18,000

10,000

Accounts Payable

Cash paid to suppliers

Purchases

on credit

13,000

18,000

13,600

slide38

Suppose C of GS was $20,000; Beg. Inv. was $12,000 and End. Inv. was $10,000; Accounts Payable had a beginning balance of $13,000 and an ending balance of $13,600. What was the cash paid to suppliers?

Inventory Cost of Gds Sold

Purchases

on credit

Inv. sold

20,000

12,000

20,000

18,000

10,000

Accounts Payable

Cash paid to suppliers

Purchases

on credit

13,000

17,400

18,000

Cash

paid

13,600

direct method converting deferrals to cash basis
Direct Method Converting Deferrals to Cash Basis
  • Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement.
  • Cash for a deferred expense can be computed as:

Expense

Accrual Basis

+ Increase

or

- Decrease in

related PREPAID =

Expense,

Cash Basis

direct method converting deferrals to cash basis40
Direct Method Converting Deferrals to Cash Basis
  • Accounts like unearned revenue and prepaid insurance may cause the cash received or disbursed to be different from the revenue or expense shown on the income statement.
  • Cash from an unearned revenue (deferred revenue) can be computed as:

Revenue,

Accrual Basis

+ Increase

or

- Decrease in

Unearned rev. =

Revenue,

Cash Basis

direct method example
Direct MethodExample:

Suppose the Unearned Revenue account showed a beginning balance of $200 and an ending balance of $900. The income statement indicates that $1,200 is the amount of Revenue (earned) for the period. How much cash was collected for revenue (assuming A/R did not change)?

Unearned RevenueRevenue

direct method example42
Direct MethodExample:

What is cash-basis revenue??

Unearned Revenue

200

900

Revenue

1,200

1,200

determine what causes increases and decreases to each account and find the cash
Determine what causes increases and decreases to each account, and find the CASH!

Unearned Revenue

200

1200

CASH

900

Revenue

1200

1200

calculate the cash
Calculate the CASH!

Unearned Revenue

200

1200

CASH

1900

900

Revenue

1200

1200

calculate the cash45
Calculate the CASH!

Unearned Revenue

200

1200

CASH

1900

900

So,

Accrual based Revenue $1,200

+ Increase in Unearn.Rev. 700

= Cash collected from

customers $1,900

Revenue

1200

1200

to summarize
To summarize:
  • What kinds of accounts need to be examined to see if there is a difference between our accrual accounting records and actual cash?

versus

General Ledger

to summarize47
To summarize:
  • Accounts Receivable
  • Prepaids
  • Inventory
  • Accounts Payable
  • Other Payables

All current assets (except cash) and current liabilities, related to operations, need to be examined in conjunction with related revenue and expense accounts.

indirect method
Indirect Method
  • Net cash flows from operating activities are determined by . . .
    • Starting with net income, then . . .
    • Adding and subtracting items that reconcile net income to operating cash flows.
  • Requires an analysis of changes in all current asset and current liability accounts [related to operations], except cash.
indirect method conversion from net income to net cashflow from operating activities
Indirect Method: Conversion from Net Income to Net Cashflow from Operating Activities
  • Additions to net income:
    • Depreciation, depletion, and amortization.
    • All losses.
    • Decreases in current assets (other than cash).
    • Increases in current liabilities.
  • Deductions from net income:

- All gains.

- Increases in current assets (other

than cash).

- Decreases in current liabilities.

t account approach
T-account approach
  • Set up a t-account for every balance sheet account
    • Put beginning and ending balances in the accounts, using comparative balance sheets
  • Make the CASH T-account a BIG one, with room for the three sections of the Statement of Cash Flows
t account approach51
T-account approach:
  • Make every balance sheet account balance, using the income statement accounts to calculate increases and decreases to the accounts.
  • When the cash number is calculated for various increases or decreases in balance sheet accounts, put the appropriate debit or credit in the big cash T-account.
t account approach52
T-account approach:
  • Problem 12-16A (Pacific Company) is a good demonstration problem of using the T-account approach to prepare a Statement of Cash Flows using the direct method.

Let’s do

12-16A

But first, there are just a few more slides to summarize things.

summary of differences between direct and indirect methods
Summary of Differences Between Direct and Indirect Methods
  • The direct method provides more detail about cash from operating activities.
    • Shows individual operating cash flows.
    • Shows reconciliation of operating cash flows to net income in a supplemental schedule.
  • The investing and financing sections for the two methods are identical.
  • Net cash flow from Operating Activities and total net cash flow are the same for both methods.
  • The schedule of Noncash Investing/Financing Activities is identical for both methods.
how important is the statement of cash flows
How important is the Statement of Cash Flows?
  • It is crucial to the presentation of a complete picture of the financial status of a business.
  • Many businesses with great ideas and potential have failed due to their failure to manage their cash flows.
  • Remember, the statement is REQUIRED by GAAP.
chapter 1255
Chapter 12

This course is FINISHED!!