Financial Accounting and Accounting Standards

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UNIT 8 SEMINARUNIT 8 SEMINAR

STATEMENT OF CASH FLOWSSTATEMENT OF CASH FLOWS

CHAPTER 13CHAPTER 13

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study objectives

1.1.Indicate the usefulness of the statement of cashflows.

2.2.Distinguish among operating, investing, and financingactivities.

3.3.Prepare a statement of cash flows using the indirectmethod.

4.4.Analyze the statement of cash flows.

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preview of chapter 13

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

Help investors, creditors, and others to assess:

1.Entity’s ability to generate future cash flows.

2.Entity’s ability to pay dividends and obligations.

3.Reasons for difference between net income and net cashprovided (used) by operating activities.

4.Cash investing and financing transactions during theperiod.

Statement of Cash FlowsStatement of Cash Flows

Usefulness of the Statement of Cash Flows

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

IncomeStatement Items

OperatingActivities

Generally Long-Term AssetItems

InvestingActivities

Generally Long-Term Liabilityand EquityItems

FinancingActivities

Classification of Cash Flows

Statement of Cash FlowsStatement of Cash Flows

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

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 services.

To government for taxes.

To lenders for interest.

To others for expenses.

Illustration 13-1

Types of Cash Inflows and Outflows

Statement of Cash FlowsStatement of Cash Flows

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Types of Cash Inflows and Outflows

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

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 13-1

Statement of Cash FlowsStatement of Cash Flows

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

Financing activities - Changes in long-term liabilities andstockholders’ equity

Cash inflows:

From sale of common stock.

From issuance of long-term debt (bonds and notes).

Cash outflows:

To stockholders as dividends.

To redeem long-term debt or reacquire capital stock

(treasury stock).

Illustration 13-1

Types of Cash Inflows and Outflows

Statement of Cash FlowsStatement of Cash Flows

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Significant Noncash Activities

1.Direct issuance of common stock to purchase assets.

2.Conversion of bonds into common stock.

3.Direct issuance of debt to purchase assets.

4.Exchanges of plant assets.

Companies report these activities in either a separateschedule at the bottom of the statement of cash flows orin a separate note or supplementary schedule to thefinancial statements.

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

Statement of Cash FlowsStatement of Cash Flows

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Direct Method

Indirect Method

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

Statement of Cash FlowsStatement of Cash Flows

Format of the Statement of Cash Flows

Order of Presentation:

1.Operating activities.

2.Investing activities.

3.Financing activities.

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Illustration 13-2

Format of the Statement of Cash FlowsFormat of the Statement of Cash Flows

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

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During its first week, KR Christel Company hadthese transactions.

1.Issued 100,000 shares of $5 par value common stock for$800,000 cash.

2.Borrowed $200,000 from Castle Bank, signing a 5-year notebearing 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.

Classify each of these transactions by type of cash flow activity.

Statement of Cash FlowsStatement of Cash Flows

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

Financing

Investing

Operating

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Three Sources of Information:

1.Comparative balance sheets

2.Current income statement

3.Additional information

Preparing the Statement of Cash FlowsPreparing the Statement of Cash Flows

Three Major Steps:

Illustration 13-3

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

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Preparing the Statement of Cash FlowsPreparing the Statement of Cash Flows

Three Major Steps:

Illustration 13-3

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

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Indirect and Direct Methods

Companies favor the indirectmethod for two reasons:

1.It is easier and less costly toprepare, and

2.It focuses on the differencesbetween net income and netcash flow from operatingactivities.

Preparing the Statement of Cash FlowsPreparing the Statement of Cash Flows

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

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Preparing the Statement of Cash FlowsPreparing the Statement of Cash Flows

SO 3 Prepare a statement of cash flows using the indirect method.

IndirectMethod

Illustration 13-4

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SO 3 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash FlowsPreparing the Statement of Cash Flows

IndirectMethod

Illustration 13-4

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SO 3 Prepare a statement of cash flows using the indirect method.

Additional information for 2011:

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.

Illustration 13-4

Preparing the Statement of Cash FlowsPreparing the Statement of Cash Flows

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Step 1: Operating Activities

Determine net cash provided/used by operating activitiesby converting net income from an accrual basis to a cashbasis.

SO 3 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows –Indirect MethodPreparing the Statement of Cash Flows –Indirect Method

Common adjustments to Net Income (Loss):

Add back non-cash expenses (depreciation andamortization expense).

Deduct gains and add losses.

The change in noncash current assets and currentliabilities.

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Which is an example of a cash flow from anoperating 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’sstockholders.

d.None of the above.

Question

SO 3 Prepare a statement of cash flows using the indirect method.

Step 1: Operating ActivitiesStep 1: Operating Activities

Solution onnotes page

Which is an example of a cash flow from anoperating 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’sstockholders.

d.None of the above.

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Depreciation Expense

Although depreciation expense reduces net income, itdoes not reduce cash. Depreciation is a noncashcharge. The company must add it back to net income.

SO 3 Prepare a statement of cash flows using the indirect method.

Illustration 13-6

Step 1: Operating ActivitiesStep 1: Operating Activities

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Loss on Sale of Equipment

Because companies report as a source of cash in theinvesting activities section the actual amount of cashreceived from the sale:

Any loss on sale is added to net income in theoperating section.

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

SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Illustration 13-7

Loss on Sale of Equipment

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Changes to Noncash Current Asset Accounts

When the Accounts Receivable balance decreases, cashreceipts are higher than revenue earned under theaccrual basis.

SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Therefore, the company adds to net income the amountof the decrease in accounts receivable.

Accounts Receivable

1/1/011 Balance 30,000

Revenues 507,000

Receipts from customers 517,000

12/31/11 Balance 20,000

Illustration 13-8

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Illustration 13-9

Changes to Noncash Current Asset Accounts

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When the Inventory balance increases, the cost ofmerchandise purchased exceeds the cost of goods sold.

SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Changes to Noncash Current Asset Accounts

Merchandise Inventory

1/1/11 Balance 10,000

Purchases 155,000

Cost of goods sold 150,000

12/31/11 Balance 15,000

As a result, cost of goods sold does not reflect cashpayments made for merchandise. The company deductsfrom net income this inventory increase.

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Illustration 13-9

Changes to Noncash Current Asset Accounts

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When the Prepaid Expense balance increases, cash paidfor expenses is higher than expenses reported on anaccrual basis. The company deducts the decrease fromnet income to arrive at net cash provided by operatingactivities.

If prepaid expenses decrease, reported expenses arehigher than the expenses paid.

SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Changes to Noncash Current Asset Accounts

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Illustration 13-9

Changes to Noncash Current Asset Accounts

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Changes to Noncash Current Liability Accounts

When Accounts Payable increases, this means the companyreceived more in goods than it actually paid for. Theincrease is added to net income to determine net cashprovided by operating activities.

When Income Tax Payable decreases, this means theincome tax expense reported on the income statement wasless than the amount of taxes paid during the period. Thedecrease is subtracted from net income to determine netcash provided by operating activities.

SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Illustration 13-10

Changes to Noncash Current Liability Accounts

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating ActivitiesOperating Activities

Illustration 13-11

Summary of Conversion to NetCash Provided by OperatingActivities—Indirect Method

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Josh’s PhotoPlus reported net income of$73,000 for 2011. Included in the income

statement were depreciation expense of $7,000 and a gain onsale of equipment of $2,500. Josh’s comparative balancesheets show the following balances.

Operating ActivitiesOperating Activities

Calculate net cash provided by operating activities forJosh’s PhotoPlus.

SO 3 Prepare a statement of cash flows using the indirect method.

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Calculate net cash provided by operatingactivities for Josh’s PhotoPlus.

Operating ActivitiesOperating Activities

Solution onnotes page

SO 3 Prepare a statement of cash flows using the indirect method.

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From the additional information, the company purchased landof $110,000 by issuing long-term bonds. This is a significantnoncash investing and financing activity that merits disclosurein a separate schedule.

SO 3 Prepare a statement of cash flows using the indirect method.

Step 2: Investing and Financing ActivitiesStep 2: Investing and Financing Activities

Land

1/1/11 Balance 20,000

Issued bonds 110,000

12/31/11 Balance 130,000

Bonds Payable

1/1/11 Balance 20,000

For land 110,000

12/31/11 Balance 130,000

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SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing ActivitiesInvesting and Financing Activities

Illustration 13-13

Partial statement

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

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing ActivitiesInvesting and Financing Activities

1/1/11 Balance 40,000

Office building 120,000

12/31/11 Balance 160,000

Building

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SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing ActivitiesInvesting and Financing Activities

Illustration 13-13

Partial statement

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The additional information explains that the equipmentincrease resulted from two transactions: (1) a purchase ofequipment of $25,000, and (2) the sale for $4,000 ofequipment costing $8,000.

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing ActivitiesInvesting and Financing Activities

1/1/11 Balance 10,000

Purchase 25,000

12/31/11 Balance 27,000

Equipment sold 8,000

Cash4,000

Accumulated depreciation1,000

Loss on sale of equipment3,000

Equipment8,000

JournalEntry

Equipment

Illustration 13-12

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SO 3 Prepare a statement of cash flows using the indirect method.

Statementof CashFlowsStatementof CashFlows

Illustration 13-13

IndirectMethod

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The additional information notes that the increase incommon stock resulted from the issuance of new shares.

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing ActivitiesInvesting and Financing Activities

1/1/11 Balance 50,000

Shares sold 20,000

12/31/11 Balance 70,000

Common Stock

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Investing and Financing ActivitiesInvesting and Financing Activities

Illustration 13-13

Partial statement

SO 3 Prepare a statement of cash flows using the indirect method.

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Retained earnings increased $116,000 during the year. Thisincrease can be explained by two factors: (1) Net income of$145,000 increased retained earnings. (2) Dividends of$29,000 decreased retained earnings

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing ActivitiesInvesting and Financing Activities

1/1/11 Balance 48,000

Net income 145,000

12/31/11 Balance 164,000

Dividends 29,000

Retained Earnings

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SO 3 Prepare a statement of cash flows using the indirect method.

Statementof CashFlowsStatementof CashFlows

Illustration 13-13

IndirectMethod

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Which is an example of a cash flow from an investingactivity?

a.Receipt of cash from the issuance of bondspayable.

b.Payment of cash to repurchase outstandingcapital stock.

c.Receipt of cash from the sale of equipment.

d.Payment of cash to suppliers for inventory.

QuestionQuestion

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing ActivitiesInvesting and Financing Activities

Which is an example of a cash flow from an investingactivity?

a.Receipt of cash from the issuance of bondspayable.

b.Payment of cash to repurchase outstandingcapital stock.

c.Receipt of cash from the sale of equipment.

d.Payment of cash to suppliers for inventory.

Solution onnotes page

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Free Cash Flow

Free cash flow describes the cash remaining fromoperations after adjustment for capital expendituresand dividends.

SO 4 Analyze the statement of cash flows.

Using Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a Company

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SO 4

Using Cash Flows to Evaluate a CompanyUsing Cash Flows to Evaluate a Company

Free CashFlow

Solution onnotes page

Illustration 13-15

Illustration 13-16

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SO 5Explain how to use a worksheet to prepare the statementof cash flows using the indirect method.

Illustration 13A-1

Using a Worksheet- Indirect Method

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Preparing a Worksheet

1.In the balance sheet accounts section, list accounts withdebit balances separately from those with credit balances.

2.Enter the reconciling columns of the worksheet the datathat explain the changes in the balance sheet accountsother than cash and their effects on the statement ofcash flows.

3.Enter on cash line and at the bottom of the worksheet theincrease or decrease in cash. This entry should enable thetotals of the reconciling columns to be in agreement.

SO 5Explain how to use a worksheet to prepare the statementof cash flows using the indirect method.

Using a Worksheet- Indirect Method

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Illustration 13A-3

Completed worksheet—

indirect method

Using a Worksheet- Indirect Method

SO 5

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SO 6 Prepare a statement of cash flows using the direct method.

1.Under the direct method, companies compute net cashprovided by operating activities by adjusting each item inthe income statement from the accrual basis to the cashbasis.

2.To simplify and condense the operating activities section,companies report only major classes of operating cashreceipts and cash payments.

3.For these major classes, the difference between cashreceipts and cash payments is the net cash provided byoperating activities.

Statement of CashFlows-Direct Method

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Illustration 13B-2

SO 6 Prepare a statement of cash flows using the direct method.

Step 1: Operating Activities

Statement of CashFlows-Direct Method

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of CashFlows-Direct Method

Illustration 13B-1

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Illustration 13B-1

SO 6 Prepare a statement of cash flows using the direct method.

Statement of CashFlows-Direct Method

Additional information:

1.In 2011, the company declared and paid a $32,000 cash dividend.

2.Bonds were issued at face value for $130,000 in cash.

3.Equipment costing $180,000 was purchased for cash.

4.Equipment costing $20,000 was sold for $17,000 cash when the book valueof the equipment was $18,000.

5.Common stock of $60,000 was issued to acquire land.

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Illustration 13B-3

Cash Receipts from Customers

SO 6 Prepare a statement of cash flows using the direct method.

For Juarez Company, accounts receivable decreased $3,000.

Illustration 13B-5

Statement of CashFlows-Direct Method

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Illustration 13B-6

Cash Payments to Suppliers

SO 6 Prepare a statement of cash flows using the direct method.

In 2011, Juarez Company’s inventory increased $10,000and cash payments to suppliers were $678,000.

Illustration 13B-9

Illustration 13B-7

Statement of CashFlows-Direct Method

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Illustration 13B-10

Cash Payments for Operating Expenses

SO 6 Prepare a statement of cash flows using the direct method.

Cash payments for operating expenses were $179,000,

Illustration 13B-11

Statement of CashFlows-Direct Method

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Illustration 13B-12

Cash Payments for Income Taxes

SO 6 Prepare a statement of cash flows using the direct method.

Cash payments for income taxes were $24,000,

Illustration 13B-13

Statement of CashFlows-Direct Method

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Increase in Equipment. (1) Juarez purchased for cash equipmentcosting $180,000. And (2) it sold for $17,000 cash equipment

costing $20,000, whose book value was $18,000.

SO 6 Prepare a statement of cash flows using the direct method.

Step 2: Investing and Financing Activities

Statement of CashFlows-Direct Method

Illustration 13B-15

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Significant noncash

investing and financingtransaction.

Financing activity.

Increase in Land. Juarez’s landincreased $60,000. The additionalinformation section indicates that thecompany issued common stock topurchase the land.

SO 6 Prepare a statement of cash flows using the direct method.

Step 2: Investing and Financing Activities

Increase in Bonds Payable. BondsPayable increased $130,000. Theadditional information indicated thatJuarez issued, for $130,000 cash,bonds with a face value of $130,000.

Statement of CashFlows-Direct Method

Solution onnotes page

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Increase in Common Stock. TheCommon Stock account increased$60,000. The additional informationindicated that Juarez acquired landfrom the issuance of common

stock.

SO 6 Prepare a statement of cash flows using the direct method.

Step 2: Investing and Financing Activities

Increase in Retained Earnings. The$52,000 net increase in RetainedEarnings resulted from net income of$84,000 and the declaration andpayment of a cash dividend

of $32,000.

Financing activity(cash dividend).

Significant noncash

investing and financingtransaction.

Statement of CashFlows-Direct Method

Solution onnotes page

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Step 2:InvestingandFinancingActivities

Illustration 13B-16

Statement of CashFlows-Direct Method

SO 6

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THE ENDTHE END