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Chapter 16. Statement of Cash Flows. Objective 1. Describe the cash flow activities reported in the statement of cash flows.

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slide1

Chapter 16

Statement of Cash Flows

slide2

Objective 1

Describe the cash flow activities reported in the statement of cash flows

slide3

The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a company’s ability to do the following:

  • Generate cash from operations
  • Maintain and expand its operating capacity
  • Meet its financial obligations
  • Pay dividends
slide4

Reporting Cash Flows

The statement of cash flows reports cash flows from three types of activities:

1.Cash flows from operating activities are cash flows from transactions that affect net income.

2.Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets of the company.

3.Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the company.

slide5

Exhibit 1

Cash Flows

slide6

Cash Flows from Operating Activities

The direct method reports the sources of operating cash and the uses of operating cash.

slide7

The indirect method reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash.

slide8

The primary advantage of the indirect method is that it reconciles the difference between net income and net cash flows from operations. Also, the indirect method is less costly to use than the direct method.

If you use the direct method, you will need to provide a reconciliation—which is the indirect method.

Over 99% of companies use the indirect method.

slide9

Exhibit 2

Cash Flows from Operations: Direct and Indirect Methods—NetSolutions

The same

slide10

Cash Flows from Investing Activities

  • Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.
  • Cashoutflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.
slide11

Cash Flows from Financing Activities

  • Cash inflows from financing activities normally arise from issuing debt or equity securities.
  • Cashoutflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock.
slide12

Noncash Investing and Financing Activities

Noncash investing and financing activities are transactions that do not directly affect cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows.

slide13

No Cash Flow Per Share

Cash flow per share should not be reported on a company’s financial statements for the following reasons:

  • Users may misinterpret cash flow per share as the per-share amount available for dividends.
  • Users may misinterpret cash flow per share as equivalent to earnings per share.
slide14

Example Exercise 16-1

Classifying Cash Flows

Identify whether each of the following would be reported as an operating, investing, or financing activity in the statement of cash flows.

  • Purchase of patent d. Cash sale
  • Payment of cash dividend e. Purchase of treasury stock
  • Disposal of equipment f. Payment of wages expense
slide15

Example Exercise 16-1 (continued)

i

o

  • Purchase of patent d. Cash sale
  • Payment of cash dividend e. Purchase of treasury stock
  • Disposal of equipment f. Payment of wages expense

f

f

i

o

slide16

Objective 2

Prepare a statement of cash flows, using the indirect method.

slide17

Efficient Approach

The indirect method of reporting cash flows from operating activities uses the logic that a change in any balance sheet account (including Cash) can be analyzed in terms of changes in other balance sheet accounts.

slide18

Exhibit 3

Income Statement and Comparative Balance Sheet

(continued)

slide19

Exhibit 3

Income Statement and Comparative Balance Sheet (continued)

slide20

Retained Earnings

The analysis of Retained Earningsprovides a good starting point for determining the cash flows from operating activities.

slide21

The net income of $108,000 is the first amount reported in the Cash Flows from Operating Activities section.

The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year.

slide22

Cash flows from operating activities:

Net income $108,000

Adjustments to reconcile net income to net cash flow from operating activities:

Adjustments to Net Income

This phrase is added to indicate that accrual basis net income is being adjusted to arrive at cash flows from operations.

slide23

Exhibit 4

Adjustments to Net Income (Loss) Using the Indirect Method

Step 1

Step 2

Step 3

slide24

Step 1

Expenses that do not affect cash are added. Such expenses decreased net income, but did not involve cash payments and, thus, are added to net income. Examples include depreciation of fixed assets and amortization of intangible assets.

slide25

Step 2

Loses and gains on disposal of assets are added or deducted. The disposal (sale) of assets is an investing activity, rather than an operating activity. Losses on disposal of assets are added back to net income. Gains on disposal of assets are deducted from net income.

slide26

Step 3

Changes in current operating assets and liabilities are added or deducted as follows:

  • Increases in noncash current operating assets are deducted.
  • Decreases in noncash current operating assets are added.
  • Increases in current operating liabilities are added.
  • Decreases in current operating liabilities are deducted.
slide27

Example Exercise 16-2

Adjustments to Net Income—Indirect Method

Omni Corporation’s accumulated depreciation increased by $12,000, while patents decreased by $3,400 between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from sale of land. Reconcile a net income of $50,000 to net cash flow from operating activities.

slide28

Net income………………………………………. $50,000

Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation…………………………………. 12,000

Amortization of patents………………………. 3,400

Gain on sale of land………………………... (4,100)

Net cash flow from operating activities…….. $61,300

Example Exercise 16-2 (continued)

slide29

Exhibit 5

Cash Flows from Operating Activities—Indirect Method

Step 1

Step 2

Step 3

(continued on Slide 31)

slide30

The account, shown below, indicates that Accumulated Depreciation—Building increased by $7,000.

Step 1:The comparative balance sheets indicate that Accumulated Depreciation—Building increased by $7,000.

slide31

Exhibit 5

Cash Flows from Operating Activities—Indirect Method (continued)

Step 1

(continued)

slide32

Step 2

The proceeds, which included the gain, are reported in the Investing section of the statement of cash flows. Thus, the $12,000 is deducted from net income in determining cash flows from operating activities.

slide33

Exhibit 5

Cash Flows from Operating Activities—Indirect Method (continued)

(continued)

slide34

Step 3

Next, select the current operating assets and liabilitiesthat impact cash flows and determine their increases and decreases. Slide 35 may prove helpful.

slide35

December 31

Increase

Decrease*

2009

2010

9,000

8,000*

3,200*

2,200

500*

Accounts receivable (net) $ 74,000 $ 65,000

Inventories 172,000 180,000

Accounts payable (mdse.) 43,500 46,700

Accrued expenses payable 26,500 24,300

Income taxes payable 7,900 8,400

Note that Cash and Dividends Payable are not included in this analysis.

slide36

Exhibit 5

Cash Flows from Operating Activities—Indirect Method (concluded)

Step 1

Step 2

Step 3

slide37

Example Exercise 16-3

Changes in Current Operating Assets and Liabilities—Indirect Method

Victor Corporation’s comparative balance sheet for current assets and current liabilities was as follows:

Dec. 31, 2011

Dec. 31, 2010

Accounts receivable $ 6,500 $ 4,900

Inventory 12,300 15,000

Accounts payable 4,800 5,200

Dividends payable 5,000 4,000

Adjust net income of $70,000 for changes in operating assets and liabilities to arrive at cash flows from operating activities.

slide38

Net income…………………………………………….. $70,000

Adjustments to reconcile net income to net cash flow from operating activities:

Increase in accounts receivable………………. (1,600)

Decrease in inventory…………………………... 2,700

Decrease in accounts payable………………… (400)

Net cash flow from operating activities …..…..…. $70,700

Example Exercise 16-3 (continued)

slide39

Example Exercise 16-4

Cash Flows from Operating Activities—Indirect Method

Omicron, Inc. reported the following data:

Net income $120,000

Depreciation expense 12,000

Loss on disposal of equipment 15,000

Increase in Accounts receivable 5,000

Decrease in Accounts payable (2,000)

Prepare the cash flows for operating activities section of the statement of cash flows using the indirect method.

slide40

Cash flows from operating activities:

Net income……………………………………….. $120,000 Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation………………………………….. 12,000

Loss from disposal of equipment………... 15,000

Changes in current operating assets and liabilities:

Increase in accounts receivable………….. (5,000)

Decrease in accounts payable…………….. (2,000)

Net cash flow from operating activities……... $140,000

Example Exercise 16-4 (continued)

slide41

Dividends

Cash dividends of $28,000 were declared during 2010. Note the entry highlighted in yellow.

slide42

Only $24,000 of the dividends was paid in 2010.

Since dividend payments are a financing activity, the dividend payment is reported in the Financing Activities section.

slide43

Common Stock

Rundell, Inc.’s Common Stock account increased by $8,000 during 2010.

slide44

Paid-in Capital in Excess of Par—Common Stock increased $40,000 during the year.

Issuing company stock is a financing activity, so cash flows from financing activities increases by $48,000 ($8,000 + $40,000).

slide45

Bonds Payable

Bonds Payable decreased $50,000 during 2010. A check with Rundell’s income statement show that there was no gain or loss on the retirement.

Retiring a bond payable is a financing activity, so a cash outflow of $50,000 is reported in the Financing Activities section of the statement of cash flows.

slide46

Building

The Building account increased by $60,000.

The cash outflow for this purchase is shown in the Financing Activities section of the statement.

slide47

Land

The $45,000 decline in the Land account was from two transactions.

slide48

Earlier, as part of Step 2 in preparing the Operating Activities section, the $12,000 gain was deducted from net income.

Step 2

The proceeds of $72,000 from the sale of land are reported in the Investing Activities section of the statement of cash flows.

slide49

The October 12 transaction is the purchase of land for cash of $15,000. This transaction is reported as an outflow of cash in the Cash Flows from Investing Activities section.

slide50

Example Exercise 16-5

Land Transactions on the Statement of Cash Flows

Alpha Corporation purchased land for $125,000. Later in the year the company sold land with a book value of $165,000 for $200,000. How are the effects of these transactions reported on the statement of cash flows?

slide51

Example Exercise 16-5 (continued)

The gain on sale of land is deducted from net income as shown below:

Gainon sale of land………………..$(35,000)

The purchase and sale of land is reported as part of cash inflow from investing activities as shown below:

Cash received for sale of land…… $200,000

Cash paid for purchase of land….. (125,000)

slide52

Exhibit 6

Statement of Cash Flows—Indirect Method

payable

slide53

Objective 3

Prepare a statement of cash flows, using the direct method.

slide54

The Direct Method

The final amount reported in the Cash Flows from Operating Activities section will be the same whether the direct or indirect approach is used. The methods differin how the data are obtained, analyzed, and reported.

slide55

Cash Received from Customers

Rundell, Inc. reports sales of $1,180,000 for 2010. To determine the cash received from customers, sales are adjusted by any increase or decrease in accounts receivable.

slide56

$0

$1,180,000

= $1,171,000

$(9,000)

slide57

Example Exercise 16-6

Cash Received from Customers—Direct Method

Sales reported on the income statement were $350,000. The accounts receivable balance declined $8,000 over the year. Determine the amount of cash received from customers.

Sales……………………………………………… $350,000

Add decrease in accounts receivable……… 8,000

Cash received from customers……………… $358,000

slide58

Cash Payments for Merchandise

Rundell, Inc. reports cost of merchandise sold of $790,000. To determine the cash payment for merchandise, the $790,000 is adjusted for any increase or decrease in inventories and accounts payable (assuming the accounts payable are owed to merchandise suppliers).

slide59

$(8,000)

$790,000

= $785,200

$3,200

slide60

Example Exercise 16-7

Cash Payment for Merchandise—Direct Method

Cost of merchandise sold reported on the income statement was $145,000. The accounts payable balance increased $4,000, and the inventory balance increased by $9,000 over the year. Determine the amount of cash paid for merchandise.

Cost of merchandise sold……………………… $145,000

Add increase in inventory……………………… 9,000

Deduct increase in accounts payable……….. (4,000)

Cash paid for merchandise……………………. $150,000

slide61

Cash Payments for Operating Expenses

Rundell, Inc. reports total operating expenses of $203,000, which includes depreciation expense of $7,000. To determine cash payments for operating expenses, the other operating expenses (excluding depreciation) of $196,000 are adjusted for any increase or decrease in accrued expenses payable.

slide62

$0

$196,000

= $193,800

$(2,200)

slide63

Interest Expense

Rundell, Inc. reports interest expense of 8,000. To determine the cash payments for interest, the $8,000 is adjusted for any increases or decreases in interest payable.

slide64

$0

$8,000

= $8,000

$0

slide65

Cash Payments for Income Taxes

Rundell, Inc. reports income tax expense of $83,000. To determine the cash payments for income taxes, the $83,000 is adjusted for any increases or decreases in income taxes payable.

slide66

$500

$83,000

= $83,500

$0

slide67

Exhibit 7

Statement of Cash Flows—Direct Method

(continued)

slide68

Exhibit 7

Statement of Cash Flows—Direct Method (continued)