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  1. Reporting the Statement of Cash Flows Chapter 16

  2. Learning objectives • Basics of Cash flow reporting • Cash flow from operating • Cash flow from investing • Cash flow from financing • Interpretation of Statement of Cash flow • Decision analysis: Cash flow on total assets

  3. Basics of Cash flow reporting - Purpose of the Statement of Cash Flows How does a company obtain its cash? Where does a company spend its cash? What explains the change in the cash balance?

  4. Basics of Cash flow reporting - Importance of Cash Flows How did the business fund its operations? Does the business have sufficient cash to pay its debts as they mature? Did the business make any dividend payments? Did the business borrow any funds or repay any loans?

  5. Basics of Cash flow reporting - Measurement of Cash Flows Cash Cash Equivalents Currency • Short-term, highly liquid investments. • Readily convertible into cash. • So near maturity that market value is unaffected by interest rate changes.

  6. Basics of Cash flow reporting - Classifying Cash Flows The Statement of Cash Flows includes the following three sections: • Operating Activities • Investing Activities • Financing Activities

  7. Operating Activities • Inflows • Receipts from customers. • Cash dividends received. • Interest from borrowers. • Other. • Outflows • Salaries and wages. • Payments to suppliers. • Taxes and fines. • Interest paid to lenders. • Other.

  8. Investing Activities • Inflows • Selling long-term productive assets. • Selling equity investments. • Collecting principal on loans. • Other. • Outflows • Purchasing long-term productive assets. • Purchasing equity investments. • Purchasing debt investments. • Other.

  9. Financing Activities • Inflows • Issuing its own equity securities. • Issuing bonds and notes. • Issuing short- and long-term liabilities. • Outflows • Pay dividends. • Purchasing treasury stock • Repaying cash loans. • Paying owners’ withdrawals.

  10. Basics of Cash flow reporting - Noncash Investing and Financing Items requiring separate disclosure include: • Retirement of debt by issuing equity securities. • Conversion of preferred stock to common stock. • Leasing of assets in a capital lease transaction.

  11. Basics of Cash flow reporting - Format of SCF

  12. 2. Cash flow from Operating- Two methods There are two acceptable methods to determine Cash Flows from Operating Activities: Direct Method Indirect Method

  13. Let’s look at the Direct Methodfor preparing the Cash Flows from Operating Activities section.

  14. Analyzing the Cash Account Let’s use this Cash account to prepare B&G Company’s Statement of Cash Flows under the Direct Method.

  15. Let’s look at the Indirect Methodfor preparing the Cash Flows from Operating Activities section.

  16. Cash Flows from Operating Activities Net Income 2. Cash Flow from Operating - Indirect Method Changes in current assets and current liabilities. + Noncash expenses such as depreciation and amortization. + Losses and – Gains from Non-operating activities 97.5% of all companies use the indirect method.

  17. Indirect Method of Reporting Operating Cash Flows Use this table when adjusting Net Income to Operating Cash Flows.

  18. Indirect MethodExample East, Inc. reports $125,000 net income for the year ended December 31, 2005. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2005, East reported $12,500 of Depreciation Expense. What is East, Inc.’s Operating Cash Flow for 2005?

  19. Net income $ 125,000 Net income $ 125,000 Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable Cash provided by operating Cash provided by operating activities activities Indirect MethodExample For the indirect method, start with net income.

  20. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable Cash provided by operating Cash provided by operating activities activities Indirect MethodExample Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

  21. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Cash provided by operating Cash provided by operating activities activities Indirect MethodExample

  22. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Add: Increase in accounts payable 10,000 Add: Increase in accounts payable 10,000 Cash provided by operating Cash provided by operating activities activities Indirect MethodExample

  23. Net income $ 125,000 Net income $ 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts receivable (7,500) receivable (7,500) Add: Increase in accounts payable 10,000 Add: Increase in accounts payable 10,000 Cash provided by operating Cash provided by operating activities $ 140,000 activities $ 140,000 Indirect MethodExample If we used the Direct Method, we would get the same $140,000 for Cash Provided by Operating Activities.

  24. Let’s prepare a Statement of Cash Flows for B&G Company using the Indirect Method.

  25. Additional Information for 2005: • Net income was $38,000. a. The accounts payable balances result from merchandise inventory purchases. b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss. d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.

  26. Start with accrual-basis net income. Add noncash expenses and losses. Subtract noncash revenues and gains. Then, analyze the changes in current assets and current liabilities.

  27. 2. Cash Flow from operation - reconciliation with direct method

  28. Cash received from customer Vs. Accounts receivable Accounts Receivable Beg Bal: 40,000 Sales 590,000 Cash receipts 570,000 End Bal: 60,000 Increase in A/R balance from 40,000 to 60,000 indicates that the company collects $20,000 less cash from customer than is reported in sales, i.e. Cash received from customer $570,000

  29. Purchase Vs. Merchandise Inventory Merchandise inventory Beg Bal: 70,000 Cost of goods sold 300,000 Purchases 314,000 End Bal: 84,000 Increase in merchandise inventory balance from 70,000 to 84,000 indicates that the company has $14,000 higher purchase than cost of goods sold, i.e. Purchase during the period $314,000 (not the cash paid to supplier)

  30. Prepaid expense Prepaid expense Beg Bal 4,000 Wages and other operating exp 216,000 Cash payment 218,000 End Bal 6,000 Increase in prepaid expense balance from 4,000 to 6,000 indicates the company pay $2,000 less cash than operating expense, i.e. Cash payment for wage and other operating expense $218,000

  31. Cash paid for merchandise Vs. Accounts payable Accounts payable • The decrease in A/P balance from 40,000 to 35,000 indicates that company pay $5,000 more cash than purchases for the period, i.e. Cash paid for merchandise $319,000 Beg Bal 40,000 Purchases 314,000 Cash payment 319,000 End Bal 35,000

  32. Interest payable Interest payable • The decrease in interest payable balance from 4,000 to 3,000 indicates that company pay $1,000 more cash than interest expense, i.e. Cash paid for interest $8,000 Beg Bal 4,000 Interest expense 7,000 Cash paid for interest 8,000 End Bal 3,000

  33. Income tax payable Income tax payable • The increase in income tax payable balance from 12,000 to 22,000 indicates that company pay $10,000 less cash than reported income tax, i.e. Cash paid for Tax $5,000 Beg Bal 12,000 Income tax expense 15,000 Cash paid for taxes 5,000 End Bal 22,000

  34. 3. Cash flow from Investing • Additional Information for 2005: b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.

  35. Now, let’s complete the investing section.

  36. 3. Cash Flow from Investing - Reconstruction analysis

  37. 3. Cash Flow from Investing - Reconstruction analysis • b. Purchased plant assets costing $70,000 by paying $10,000 cash and issuing $60,000 of bonds payable. • c. Sold plant assets with an original cost of $30,000 and accumulated depreciation of $12,000 for $12,000 cash, yielding a $6,000 loss.

  38. Accumulated Depreciation Beg. Bal 48,000 Sale 12,000 Dep. Expense 24,000 End Bal. 60,000 Plant Assets Beg Bal 210,000 Sale 30,000 Purchase 70,000 End Bal 250,000

  39. 4. Cash flow from Financing • Additional Information for 2005: d. Received cash of $15,000 from issuing 3,000 shares of common stock. e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. f. Cash dividends declared and paid were $14,000.

  40. Now, let’s complete the financing section.

  41. 4. Cash Flow from Financing - Reconstruction analysis

  42. 4. Cash Flow from Financing - Reconstruction analysis • d. Received cash of $15,000 from issuing 3,000 shares of common stock. • e. Paid $18,000 cash to retire bonds with a $34000 book value, yielding a $16000 gain. • f. Cash dividends declared and paid were $14,000.

  43. Bond Payable Beg. Bal 64,000 Retired bond 34,000 Issue bonds 60,000 End Bal. 90,000 Common Stock Retained Earning Beg Bal 80,000 Beg Bal 88,000 Issue stock 15 ,000 Cash dividend 14,000 Net Income 38,000 End Bal 95,000 End Bal 112,000 4. Cash Flow from Financing - Reconstruction analysis

  44. 5. Interpretation of SCF - Analyzing Cash Sources and Uses

  45. 5. Interpretation of SCF - Analyzing Cash Sources and Uses

  46. 5. Interpretation of SCF - Analyzing Cash Sources and Uses