Statement of Cash Flows

Chapter 12-1

Financial Accounting, Fifth Edition

Study Objectives
1. 2. 3. 4. 5. 6. Indicate the usefulness of the statement of cash flows. Distinguish among operating, investing, and financing activities. Explain the impact of the product life cycle on a companys cash flows. Prepare a statement of cash flows using the indirect method. Use the statement of cash flows to evaluate a company. Prepare a statement of cash flows using the direct method.

Chapter 12-2

Statement of Cash Flows

The Statement of Cash Flows: Usefulness and Format

Usefulness Classifications Significant noncash activities Format Corporate life cycle Preparation Indirect and direct methods
Chapter 12-3

Preparing the Statement of Cash FlowsIndirect Method

Step 1: Operating activities Step 2: Investing and financing activities Step 3: Net change in cash

Using Cash Flows to Evaluate a Company

Free cash flow Assessing liquidity and solvency

Usefulness of the Statement of Cash Flows

Provides information to help assess:
1. Entitys ability to generate future cash flows. 2. Entitys ability to pay dividends and obligations. 3. Reasons for difference between net income and net cash provided (used) by operating activities. 4. Cash investing and financing transactions during the period.

Chapter 12-4

SO 1 Indicate the usefulness of the statement of cash flows.

Classification of Cash Flows

Operating
Activities
Income

Investing
Activities
Generally Long-Term Asset Items

Financing
Activities
Generally Long-Term Liability and Equity Items

Statement
Items

Chapter 12-5

SO 2 Distinguish among operating, investing, and financing activities.

Classification of Cash Flows

Types of Cash Inflows and Outflows
Illustration 12-1

Chapter 12-6

SO 2 Distinguish among operating, investing, and financing activities.

Classification of Cash Flows

Types of Cash Inflows and Outflows
Illustration 12-1

Chapter 12-7

SO 2 Distinguish among operating, investing, and financing activities.

Significant Noncash Activities

1. Issuance of common stock to purchase assets.

2. Conversion of bonds into common stock.

3. Issuance of debt to purchase assets. 4. Exchanges of plant assets.
Companies report these activities in either a separate schedule at the bottom of the statement of cash flows or in a separate note or supplementary schedule to the financial statements.

Chapter 12-8

SO 2 Distinguish among operating, investing, and financing activities.

Chapter 12-9

Format of the Statement of Cash Flows

Order of Presentation:
1. 2. 3.

Operating activities. Investing activities. Financing activities.

Direct Method
Indirect Method

The cash flows from operating activities section always appears first, followed by the investing and financing sections.
Chapter 12-10

SO 2 Distinguish among operating, investing, and financing activities.

Format of the Statement of Cash Flows

Illustration 12-2

Chapter 12-11

SO 2 Distinguish among operating, investing, and financing activities.

Format of the Statement of Cash Flows

Illustration: Classify each of these transactions by type of cash flow activity.
1. Issued 100,000 shares of $5 par value common stock for $800,000 cash. 2. Borrowed $200,000, signing a 5-year note bearing 8% interest. 3. Purchased two semi-trailer trucks for $170,000 cash. 4. Paid employees $12,000 for salaries and wages. 5. Collected $20,000 cash for services provided.
Chapter 12-12

Financing Financing Investing

Operating
Operating

SO 2 Distinguish among operating, investing, and financing activities.

The Corporate Life Cycle

Illustration 12-3

All products go through a series of phases called the product life cycle.

Chapter 12-13

SO 3 Explain the impact of the product life cycle on a companys cash flows.

Preparing the Statement of Cash Flows

Three Sources of Information:
1. Comparative balance sheets 2. Current income statement 3. Additional information

Three Major Steps:

Illustration 12-4

Chapter 12-14

SO 3 Explain the impact of the product life cycle on a companys cash flows.

Preparing the Statement of Cash Flows

Three Major Steps:
Illustration 12-4

Chapter 12-15

SO 3 Explain the impact of the product life cycle on a companys cash flows.

Indirect and Direct Methods

Companies favor the indirect method for two reasons:
1. Easier and less costly to prepare.

2. Focuses on differences between net income and net cash flow from operating activities.

Chapter 12-16

SO 3 Explain the impact of the product life cycle on a companys cash flows.

Preparing the Statement of Cash Flows

Illustration Indirect Method
Illustration 12-5

Chapter 12-17

SO 4 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows

Illustration 12-5

Chapter 12-18

SO 4 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows

Illustration 12-5

Additional information for 2010: 1. The company declared and paid a $29,000 cash dividend. 2. Issued $110,000 of long-term bonds in direct exchange for land. 3. A building costing $120,000 and equipment costing $25,000 were purchased for cash. 4. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000 cash. 5. Issued common stock for $20,000 cash. 6. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.
Chapter 12-19

SO 4 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows Indirect Method

Step 1: Operating Activities
Determine net cash provided/used by operating activities by converting net income from accrual basis to cash basis.

Common adjustments to Net Income (Loss):

Add back non-cash expenses (depreciation, amortization, or depletion expense). Deduct gains and add losses. Changes in noncash current assets and current liabilities.
Chapter 12-20

SO 4 Prepare a statement of cash flows using the indirect method.

Step 1: Operating Activities

Question
Which is an example of a cash flow from an operating activity? a. Payment of cash to lenders for interest. b. Receipt of cash from the sale of capital stock.

c. Payment of cash dividends to the companys stockholders.

d. None of the above.

Chapter 12-21

SO 4 Prepare a statement of cash flows using the indirect method.

Step 1: Operating Activities

Depreciation Expense
Although depreciation expense reduces net income, it does not reduce cash. The company must add it back to net income.
Illustration 12-7

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Net cash provided by operating activities

145,000

9,000 154,000

Chapter 12-22

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Loss on Sale of Equipment
Because companies report as a source of cash in the investing activities section the actual amount of cash received from the sale: Any loss on sale is added to net income in the operating section.

Any gain on sale is deducted from net income in the operating section.

Chapter 12-23

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Loss on Sale of Equipment
Illustration 12-8

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Net cash provided by operating activities

145,000

9,000 3,000 157,000

Chapter 12-24

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Asset Accounts
When the Accounts Receivable balance decreases, cash receipts are higher than revenue earned under the accrual basis.
Accounts Receivable 1/1/010 Balance Revenues 30,000 507,000 20,000 Receipts from customers 517,000

Illustration 12-9

12/31/10 Balance

Therefore, the company adds to net income the amount of the decrease in accounts receivable.
Chapter 12-25

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Asset Accounts
Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Net cash provided by operating activities
Illustration 12-10

145,000

9,000 3,000 10,000 167,000

Chapter 12-26

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Asset Accounts
When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold.
Merchandise Inventory 1/1/10 Balance Purchases 10,000 155,000 15,000 Cost of goods sold 150,000

12/31/10 Balance

As a result, cost of goods sold does not reflect cash payments made for merchandise. The company deducts from net income this inventory increase.
Chapter 12-27

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Asset Accounts
Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Net cash provided by operating activities
Illustration 12-10

145,000

9,000 3,000 10,000 (5,000) 162,000

Chapter 12-28

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Asset Accounts
When the Prepaid Expense balance increases, cash paid for expenses is higher than expenses reported on an accrual basis. The company deducts the decrease from net income to arrive at net cash provided by operating activities. If prepaid expenses decrease, reported expenses are higher than the expenses paid.

Chapter 12-29

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Asset Accounts
Illustration 12-10

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Net cash provided by operating activities

145,000

9,000 3,000 10,000 (5,000) (4,000) 158,000

Chapter 12-30

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Liability Accounts
When Accounts Payable increases, this means the company received more in goods than it actually paid for. The increase is added to net income to determine net cash provided by operating activities.
When Income Tax Payable decreases, this means the income tax expense reported on the income statement was less than the amount of taxes paid during the period. The decrease is subtracted from net income to determine net cash provided by operating activities.
Chapter 12-31

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Noncash Current Liability Accounts
Illustration 12-11

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities
Chapter 12-32

145,000

9,000 3,000 10,000 (5,000) (4,000) 16,000 (2,000) 172,000

SO 4 Prepare a statement of cash flows using the indirect method.

Operating Activities
Summary of Conversion to Net Cash Provided by Operating ActivitiesIndirect Method

Illustration 12-12

Chapter 12-33

SO 4 Prepare a statement of cash flows using the indirect method.

Step 2: Investing and Financing Activities

From the additional information, the company purchased land of $110,000 by issuing long-term bonds. This is a significant noncash investing and financing activity that merits disclosure in a separate schedule.
Land

1/1/10

Balance Issued bonds

20,000 110,000
130,000 Bonds Payable 1/1/10 Balance For land 20,000 110,000 130,000

12/31/10 Balance

12/31/10 Balance
Chapter 12-34

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

Partial statement
Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of common stock Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Disclosure: Issuance of bonds to purchase land
Chapter 12-35 Illustration 12-14

172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000 110,000

$ $

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

From the additional information, the company acquired an office building for $120,000 cash. This is a cash outflow reported in the investing section.

Building 1/1/10 Balance 40,000 Office building 120,000 160,000

12/31/10 Balance

Chapter 12-36

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

Partial statement
Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of common stock Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Disclosure: Issuance of bonds to purchase land
Chapter 12-37 Illustration 12-14

172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000 110,000

$ $

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

The additional information explains that the equipment increase resulted from two transactions: (1) a purchase of equipment of $25,000, and (2) the sale for $4,000 of equipment costing $8,000.
Equipment 1/1/10 Balance Purchase 10,000 25,000 27,000 Cash Accumulated depreciation Loss on sale of equipment Equipment 4,000 1,000 3,000 Equipment sold 8,000

12/31/10 Balance

Journal Entry
Chapter 12-38

8,000

SO 4 Prepare a statement of cash flows using the indirect method.

Statement of Cash Flows

Indirect Method

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of common stock Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period

Illustration 12-14

145,000

9,000 3,000 10,000 (5,000) (4,000) 16,000 (2,000) 172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000

Chapter 12-39

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

The additional information notes that the increase in common stock resulted from the issuance of new shares.
Common Stock 1/1/10 Balance Shares sold 50,000 20,000 70,000

12/31/10 Balance

Chapter 12-40

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

Partial statement
Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of common stock Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Disclosure: Issuance of bonds to purchase land
Chapter 12-41 Illustration 12-14

172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000 110,000

$ $

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

Retained earnings increased $116,000 during the year. This increase can be explained by two factors: (1) Net income of $145,000 increased retained earnings, and (2) Dividends of $29,000 decreased retained earnings.
Retained Earnings 1/1/10 Dividends 29,000 Balance Net income 48,000 145,000 164,000

12/31/10 Balance

Chapter 12-42

SO 4 Prepare a statement of cash flows using the indirect method.

Statement of Cash Flows

Indirect Method

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of common stock Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period

Illustration 12-14

145,000

9,000 3,000 10,000 (5,000) (4,000) 16,000 (2,000) 172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000

Chapter 12-43

SO 4 Prepare a statement of cash flows using the indirect method.

Step 3: Net Change in Cash

Compare the net change in cash on the Statement of Cash Flows with the change in the cash account reported on the Balance sheet to make sure the amounts agree.

Chapter 12-44

SO 4 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

Review Question
Which is an example of a cash flow from an investing activity? a. Receipt of cash from the issuance of bonds payable. b. Payment of cash to repurchase outstanding capital stock. c. Receipt of cash from the sale of equipment. d. Payment of cash to suppliers for inventory.
Chapter 12-45

SO 4 Prepare a statement of cash flows using the indirect method.