Accounting Principles

Fourteenth Edition
Weygandt Kimmel Mitchell

Chapter 17
Statement of Cash Flows

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Copyright ©2021 John Wiley & Sons, Inc.

Chapter Outline
Learning Objectives
LO 1 Discuss the usefulness and format of the statement
of cash flows.
LO 2 Prepare a statement of cash flows using the indirect
method.
LO 3 Analyze the statement of cash flows.

Copyright ©2021 John Wiley & Sons, Inc. 2

Usefulness of the Statement of Cash Flows
LEARNING OBJECTIVE 1
Discuss the usefulness and format of the statement of cash flows.

Provides information to help assess:

1. Entity’s ability to generate future cash flows.
2. Entity’s ability to pay dividends and meet
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.

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 Classification of Cash Flows

Operating Investing Financing

Activities Activities Activities
Income Changes in Changes in
Statement Items Investments Long-Term
and Long-Term Liabilities and
Asset Items Stockholders’
Equity Items

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 Classification of Cash Flows
Operating Activities—Income Statement Items
Cash inflows:
From sale of goods or services
From interest received and dividends received
Cash outflows:
To suppliers for inventory
To employees for wages
To government for taxes
To lenders for interest
To others for expenses
ILLUSTRATION 17.1
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 Classification of Cash Flows
Investing Activities—Changes in Investments
and Long-Term Assets
Cash inflows:
From sale of property, plant, and equipment
From sale of investments in debt or equity securities
From collection of principal on loans to other entities
Cash outflows:
To purchase property, plant, and equipment
To purchase investments in debt or equity securities
To make loans to other entities
ILLUSTRATION 17.1

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 Classification of Cash Flows
Financing Activities—Changes in Long-Term
Liabilities and Stockholders’ Equity
Cash inflows:
From sale of common stock
From issuance of debt (bonds and notes)
Cash outflows:
To stockholders as dividends
To redeem long-term debt or reacquire capital stock
(treasury stock)
ILLUSTRATION 17.1

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 Significant Noncash Activities
1. Direct 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 noncash activities in either a
• separate schedule (bottom of the statement) or
• separate note to the financial statements.

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Format of Statement of Cash Flows

ILLUSTRATION 17.2
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 DO IT! 1: Classification of Cash Flows
Illustration: Classify each transactions by type
of cash flow activity.
1. Issued 100,000 shares of $5 par value Financing
common stock for $800,000 cash.
2. Borrowed $200,000 from Castle Bank,
signing a 5-year note bearing 8% interest. Financing
3. Purchased two semi-trailer trucks for Investing
$170,000 cash.
4. Paid employees $12,000 for salaries and
wages.
Operating
5. Collected $20,000 cash for services
performed. Operating
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 Preparing the Statement of Cash Flows—Indirect Method

LEARNING OBJECTIVE 2

Prepare a statement of cash flows using the indirect method.

Three sources of information:

1. Comparative balance sheets
2. Current income statement
3. Additional information

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Indirect Method
Step 1

ILLUSTRATION 17.3

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Indirect Method
Step 2

ILLUSTRATION 17.3

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Indirect Method
Step 3

ILLUSTRATION 17.3

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 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.

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Indirect Method—Computer Services Co.
Comparative Balance Sheets

ILLUSTRATION 17.4

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Indirect Method—Computer Services Co.
Income Statement

ILLUSTRATION 17.4

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 Indirect Method—Computer Services Co.
Additional Information for 2022:
1. Depreciation expense was comprised of $6,000 for building and
$3,000 for equipment.
2. The company sold equipment with a book value of $7,000 (cost
$8,000, less accumulated depreciation $1,000) for $4,000 cash.
3. Issued $110,000 of long-term bonds in direct exchange for land.
4. A building costing $120,000 was purchased for cash. Equipment
costing $25,000 was also purchased for cash.
5. Issued common stock for $20,000 cash.
6. The company declared and paid a $29,000 cash dividend.
ILLUSTRATION 17.4

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 Step 1: Operating Activities

Determine Net Cash Provided/Used by Operating Activities by

Converting Net Income from an Accrual Basis to a Cash Basis
Common adjustments to Net Income (Loss):

Net Cash Provided/

Net Income +/− Adjustments = Used by Operating
Activities
• Add back noncash expenses, such as depreciation expense and amortization
expense.
• Deduct gains and add losses that
resulted from investing and financing activities.
• Analyze changes to noncash current asset and current liability accounts.

ILLUSTRATION 17.5

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 Step 1: Operating Activities
Review 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 company’s
stockholders
d. None of the above

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 Step 1: Operating Activities
Review Answer
Which is an example of a cash flow from an operating
activity?
a. Answer: Payment of cash to lenders for interest
b. Receipt of cash from the sale of capital stock
c. Payment of cash dividends to the company’s
stockholders
d. None of the above

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Step 1: Operating Activities
Adjustment for Depreciation
Although depreciation expense reduces net income, it does not
reduce cash. The company must add it back to net income.

Cash flows from operating activities

Net income $145,000
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation expense 9,000
Net cash provided by operating activities $154,000

ILLUSTRATION 17.6

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 Step 1: Operating Activities
Loss on Disposal of Plant Assets
Companies report as a source of cash in the investing
activities section the actual amount of cash received from
the sale.
• Any loss on disposal is added to net income in
operating section
• Any gain on disposal is deducted from net income in
operating section

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Step 1: Operating Activities
Adjustment for Loss on Disposal of Plant Assets

ILLUSTRATION 17.7

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Step 1: Operating Activities
Changes to Noncash Current Assets—Decrease in
Accounts Receivable
When Accounts Receivable balance decreases, cash receipts
are higher than revenue earned under accrual basis.

ILLUSTRATION 17.8

Company adds to net income amount of decrease in accounts

receivable.

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 Step 1: Operating Activities
Changes in Noncash Current Assets—Inventory

When Inventory balance increases, cost of merchandise

purchased exceeds cost of goods sold.

Company deducts increase in inventory from net income.

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 Step 1: Operating Activities
Changes to Noncash Current Assets—Increase in
Prepaid Expenses
When the Prepaid Expense balance increases, cash paid
for expenses is higher than expenses reported on an
accrual basis. The company deducts the increase from
net income to arrive at net cash provided by operating
activities.
If prepaid expenses decrease, reported expenses are
higher than the expenses paid.

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Step 1: Operating Activities
Adjustments for Changes in Current Asset Accounts

ILLUSTRATION 17.9

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 Step 1: Operating Activities
Changes in Current Liabilities
When Accounts Payable increases, company received more in
goods than it actually paid for. Increase is added to net
income to determine net cash provided by operating
activities.
When Income Tax Payable decreases, income tax expense
reported on the income statement was less than amount of
taxes paid during period. Decrease is subtracted from net
income to determine net cash provided by operating
activities.

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Step 1: Operating Activities
Adjustments for Changes in Current Liability
Accounts

ILLUSTRATION 17.10

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Summary of Conversion to Net Cash
Provided by Operating Activities—
Indirect Method

ILLUSTRATION 17.11

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 DO IT! 2a: Cash from Operating Activities

Josh’s PhotoPlus reported net income of $73,000 for 2022.

Included in the income statement were depreciation expense of
$7,000 and a gain on disposal of plant assets of $2,500. Josh’s
comparative balance sheets show the following balances.

12/31/21 12/31/22
Accounts receivable $17,000 $21,000
Accounts payable 6,000 2,200

Calculate net cash provided by operating activities for Josh’s

PhotoPlus.

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 DO IT! 2a: Cash from Operating Activities
Solution

Calculate net cash provided by operating activities.

Cash flows from operating activities
Net income $73,000
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation expense $7,000
Gain on disposal of plant assets (2,500)
Increase in accounts receivable (4,000)
Decrease in accounts payable (3,800) (3,300)
Net cash provided by operating activities $69,700

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 Step 2: Investing and Financing Activities
Increase in Land

Company purchased land of $110,000 by issuing long-

term bonds. It reports this noncash transaction in a
separate schedule at the bottom of the statement.

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 Step 2: Investing and Financing Activities
Increase in Buildings

From the additional information, the company acquired

an office building for $120,000 cash. This is a cash
outflow reported in the investing section.

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 Step 2: Investing and Financing Activities
Increase in Equipment

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.

ILLUSTRATION 17.12

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Journal Entry to Record Sale of Equipment

ILLUSTRATION 17.12

Cash 4,000
Accumulated Depreciation—Equipment 1,000
Loss on Disposal of Plant Assets 3,000
Equipment 8,000

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 Step 2: Investing and Financing Activities
Increase in Bonds Payable
The Bonds Payable account increase $110,000. The
company acquired land from an issuance of these bonds.
It reports this noncash transaction in a separate schedule
at the bottom of the statement.

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 Step 2: Investing and Financing Activities
Increase in Common Stock
The increase in common stock resulted from the issuance of
new shares.

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 Step 2: Investing and Financing Activities
Increase in Retained Earnings
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
declared of $29,000 decreased retained earnings.

ILLUSTRATION 17.13

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Statement of Cash Flows, 2022—
Indirect Method

ILLUSTRATION 17.14

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 Step 2: 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.

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 Step 2: Investing and Financing Activities
Review Answer
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. Answer: Receipt of cash from the sale of equipment.
d. Payment of cash to suppliers for inventory.

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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

ILLUSTRATION 17.4 (partial)

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Analyzing the Statement of Cash Flows
LEARNING OBJECTIVE 3
Analyze the statement of cash flows.

Free Cash Flow

Free cash flow describes the cash remaining from operations
after adjustment for capital expenditures and dividends.
Free Cash Flow = Net Cash Provided by Operating Activities -
Capital Expenditures - Cash Dividends

ILLUSTRATION 17.15

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 Free Cash Flow

ILLUSTRATION 17.17
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Statement of Cash Flows—Direct Method
LEARNING OBJECTIVE 4
Prepare a statement of cash flows using the direct method.

• Compute net cash provided by operating activities by

adjusting each item in the income statement from
accrual basis to cash basis
• Companies report only major classes of operating cash
receipts and cash payments
• For these major classes, difference between cash
receipts and cash payments is net cash provided by
operating activities

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Direct Method—Computer Services Co.
Comparative Balance Sheets

ILLUSTRATION 17A.1

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Direct Method—Computer Services Co.
Income Statement

ILLUSTRATION 17A.1

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 Direct Method—Computer Services Co.
Additional Information for 2022:
1. Depreciation expense was comprised of $6,000 for building and
$3,000 for equipment.
2. The company sold equipment with a book value of $7,000 (cost
$8,000, less accumulated depreciation $1,000) for $4,000 cash.
3. Issued $110,000 of long-term bonds in direct exchange for land.
4. A building costing $120,000 was purchased for cash. Equipment
costing $25,000 was also purchased for cash.
5. Issued common stock for $20,000 cash.
6. The company declared and paid a $29,000 cash dividend.
ILLUSTRATION 17A.1
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 Step 1: Operating Activities
Determine Net Cash Provided/Used by Operating
Activities by Converting Net Income Components from
an Accrual Basis to a Cash Basis

ILLUSTRATION 17A.2

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 Step 1: Operating Activities
Cash Receipts from Customers
For Computer Services, accounts receivable decreased $10,000.

ILLUSTRATION 17A.4

ILLUSTRATION 17A.5

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 Step 1: Operating Activities
Cash Payments to Suppliers
Inventory increased $5,000, cash payments to suppliers were $139,000.

ILLUSTRATION 17A.7

ILLUSTRATION 17A.9
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Step 1: Operating Activities
Equation to Compute Cash Payments to Suppliers—
Direct Method

ILLUSTRATION 17A.10

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 Step 1: Operating Activities
Cash Payments for Operating Expenses
Operating expenses $111,000
Add: Increase in prepaid expenses 4,000
Cash payments for operating expenses $115,000

ILLUSTRATION 17A.11

ILLUSTRATION 17A.12
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 Step 1: Operating Activities
Cash Payments for Interest

Computer Services reported interest expense of $42,000 on the

income statement.

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 Step 1: Operating Activities
Cash Payments for Income Taxes
Computer Services reported income tax expense of $47,000 on
the income statement.

ILLUSTRATION 17A.14

ILLUSTRATION 17A.15
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 Step 1: Operating Activities
Operating Activities Section of the Statement of
Cash Flows—Direct Method

ILLUSTRATION 17A.16

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 Step 2: Investing and Financing Activities
Analysis of Equipment
(1) Equipment purchased for $25,000, and (2) equipment sold for
$4,000, cost $8,000, book value $7,000.

ILLUSTRATION 17A.17

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 Step 2: Investing and Financing Activities
Increase in Land, Building, and Bonds Payable
Increase in Land. Land increased Significant noncash
$110,000. The company investing and financing
purchased land of $110,000 by transaction
issuing bonds.

Increase in Building. Acquired Investing transaction

building for $120,000 cash.

Increase in Bonds Payable. Bonds

Payable increased $110,000. The Significant noncash
company acquired land by investing and financing
exchanging bonds for land. transaction

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 Step 2: Investing and Financing Activities
Increase in Common Stock and Retained Earnings
Increase in Common Stock.
Increase in Common Stock of Financing transaction
$20,000. Increase resulted from the
issuance of new shares of stock.

Increase in Retained Earnings. The

$116,000 net increase in Retained
Earnings resulted from net income Financing transaction
of $145,000 and the declaration (cash dividend)
and payment of a cash dividend of
$29,000.

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Statement of Cash Flows—Direct Method

ILLUSTRATION 17A.18
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Worksheet for the Indirect Method
LEARNING OBJECTIVE 5
Use a worksheet to prepare the statement of cash flows
using the indirect method.

Companies may use a worksheet to assemble and classify

data that will appear on the statement of cash flows.
The worksheet is merely an aid in preparing the
statement.
Its use is optional.

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Completed Worksheet—Indirect Method

ILLUSTRATION 17B.3

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Statement of Cash Flows—T-Account Approach
LEARNING OBJECTIVE 6
Use the T-account approach to prepare a statement f cash
flows.
The change in cash is equal to the change in all of the
other balance sheet accounts.
If we analyze the changes in all of the noncash balance
sheet accounts, we will explain the change in the cash
account.

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T-Account Approach

ILLUSTRATION 17C.1

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A Look at IFRS
LEARNING OBJECTIVE 7
Compare the procedures for the statement of cash flows
under GAAP and IFRS.
• As in GAAP, the statement of cash flows is a required
statement for IFRS.
• In addition, the content and presentation of an I FRS
statement of cash flows is similar to the one used for G AAP.
• However, the disclosure requirements related to the
statement of cash flows are far more extensive under G AAP.
• IAS 7 (“Cash Flow Statements”) provides the overall I FRS
requirements for cash flow information.

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 A Look at IFRS
Similarities
• Companies preparing financial statements under IFRS must also
prepare a statement of cash flows as an integral part of the
financial statements.
• Both IFRS and GAAP require that the statement of cash flows
have three major sections—operating, investing, and financing
activities—along with changes in cash and cash equivalents.
• Similar to GAAP, the statement of cash flows can be prepared
using either the indirect or direct method under IFRS. In both
U.S. and international settings, companies choose for the most
part to use the indirect method for reporting net cash flows
from operating activities.

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 A Look at IFRS
More Similarities
• The definition of cash equivalents used in I FRS is similar to
that used in GAAP. A major difference is that in certain
situations, bank overdrafts are considered part of cash and
cash equivalents under IFRS (which is not the case in G AAP).
Under GAAP, bank overdrafts are classified as financing
activities in the statement of cash flows and are reported as
liabilities on the balance sheet.

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 A Look at IFRS
Differences
• IFRS requires that noncash investing and financing activities be
excluded from the statement of cash flows. Instead, these
noncash activities should be reported elsewhere. This
requirement is interpreted to mean that noncash investing and
financing activities should be disclosed in the notes to the
financial statements. Under GAAP, companies may present this
information on the face of the statement of cash flows.
• Under IFRS, some companies resent the operating section in a
single line item, with a full reconciliation provided in the notes
to the financial statements. This presentation is not seen under
GAAP.

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A Look at IFRS
More Differences
• One area where there can be substantial differences
between IFRS and GAAP relates to the classification of
interest, dividends, and taxes. The following table
indicates the differences between the two approaches.
Item IFRS GAAP
Interest paid Operating or financing Operating
Interest received Operating or investing Operating
Dividends paid Operating or financing Financing
Dividends received Operating or investing Operating
Taxes paid Operating—unless specific Operating
identification with financing
or investing activity

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Copyright ©2021 John Wiley & Sons, Inc. 72