Chapter 23

1. Chapter 23 Cash Flow Reporting

2. LO1 Learning Objective 1 Explain the purpose of cash flow information. The purpose of the statement of cash flows is to report all major cash receipts (inflows) and cash payments (outflows) during a period. Where does a company spend its cash? What explains the change in the cash balance? How does a company obtain its cash? Importance of Cash Flows How does the business fund its operations? Does the business have sufficient cash to pay its debts as they mature? Does the business make any dividend payments? Does the business borrow any funds or repay any loans?

3. The Statement of Cash Flows includes the following three sections: Operating Activities Investing Activities Financing Activities LO2 Learning Objective 2Distinguish between operating, investing, and financing activities. • Outflows • Salaries and wages • Payments to suppliers • Taxes and fines • Interest paid to lenders • Other • Inflows • Receipts from customers • Cash dividends received • Interest from borrowers • Other • 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 • Outflows • Paying dividends • Purchasing treasury stock • Repaying cash loans • Paying owners’ withdrawals • Inflows • Issuing its own equity securities • Issuing bonds and notes • Issuing short- and long-term liabilities

4. LO3 Learning Objective 3Describe the format of the statement of cash flows. • There are two acceptable methods to determine cash flows from operating activities: • Direct method • Indirect method 97.5% of all companies use the indirect method.

5. East, Inc. reports $125,000 net income for the year ended December 31, 2010. Accounts Receivable increased by $7,500 during the year and Accounts Payable increased by $10,000. During 2008, East reported $12,500 of Depreciation Expense. Learning Objective 4 Prepare a statement of cash flows.. LO4 The indirect method is used by almost all companies. The indirect method starts with the accrual based net income and makes certain adjustments to arrive at cash flows from operating activities. Indirect Method Example What is East, Inc.’s Operating Cash Flow for 2010?

6. LO5 Net income Net income $ $ 125,000 125,000 Net income Net income $ $ 125,000 125,000 Add: Depreciation expense 12,500 Add: Depreciation expense 12,500 Deduct: Increase in accounts Deduct: Increase in accounts Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable receivable receivable Cash provided by operating Cash provided by operating Cash provided by operating Cash provided by operating activities activities activities activities Learning Objective 5Compute cash flows from operating activities using the indirect method. For the indirect method, start with net income. Add noncash expenses such as depreciation, depletion, amortization, or bad debt expense.

7. LO5 Net income Net income $ $ 125,000 125,000 Net income Net income $ $ 125,000 125,000 Add: Depreciation expense Add: Depreciation expense 12,500 12,500 Add: Depreciation expense Add: Depreciation expense 12,500 12,500 Deduct: Increase in accounts Deduct: Increase in accounts Deduct: Increase in accounts Deduct: Increase in accounts receivable receivable (7,500) (7,500) receivable receivable (7,500) (7,500) Add: Increase in accounts payable 10,000 Add: Increase in accounts payable 10,000 Cash provided by operating Cash provided by operating Cash provided by operating Cash provided by operating activities activities activities activities Indirect Method Example

8. LO5 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 Method Example If we used the direct method, we would get the same $140,000 for cash provided by operating activities.

9. Additional Information for 2010: Net income was $105,000. Cash dividends declared and paid were $40,000. Bonds payable of $50,000 were redeemed for $50,000 cash. Common stock was issued for $35,000 cash. LO5 Let’s prepare a Statement of Cash Flows for B&G Company using the indirect method.

10. LO5 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.

11. LO6 Learning Objective 6Determine cash flows from both investing and financing activities. Reporting of investing activities is identical under the indirect method and direct method. Learning Objective 7 Analyze the statement of cash flows. LO7 Looking at the Statement of Cash Flows provides useful information that can help answer important questions about a company. Notice that while each of these companies had the same net change in cash, the change is composed of different sources and uses.

12. LO8 Cash flow on cash flow from operations = total assets Average total assets Learning Objective 8 Compute and apply the cash flow on total assets ratio. Used, along with income-based ratios, to assess company performance. 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.

13. LO9 Learning Objective 9 Appendix 23ACompute cash flows from operating activities using the direct method. • Let’s review this Cash account and determine where each of the transactions will appear on B&G’s Statement of Cash Flows. • Receipts from customers will appear in the operating section. • Receipts from sale of land will appear in the investing section. • Receipts from stock issuance will appear in the financing section. • Payments for merchandise, wages, interest and taxes will appear in the operating section. • Payments for equipment will appear in the investing section. • And finally, payments for bond retirement and dividends will appear in the financing section. • Now, let’s look at a completed Statement of Cash Flows for B&G.

14. LO9 Notice how the transactions are properly classified based on our analysis on the previous slide. The statement also includes the cash reconciliation at the end.

15. End of Chapter 23