cash flow statement

Horngren, Harrison, Bamber, Best, Fraser, Willett: Accounting 5e © 2007 Pearson Education Australia

The Cash Flow StatementOBJECTIVES

Identify the purposes of the cash flow statement 2. Report cash flows from operating, investing and

financing activities3. Prepare a cash flow statement by the indirect method4. Calculate the cash effects of a wide variety of business

transactions5. Prepare a cash flow statement by the direct method6. Prepare a bank reconciliation and the related journal entries


The cash flow statementreports the entity’s cash flows

(cash receipts and cash payments)during the period.

The Cash Flow Statement: Basic Concepts


Purposes of the Cash Flow Statement 30/6/06 For the Year Ended 30/6/07 30/6/07(a point in time) (a period of time) (a point in time)

Cash Flow Statement

Income Statement

BalanceSheet

Balance Sheet


Cash Balance Includes...

– cash on hand

– cash in the bank

– cash equivalents.


Cash Equivalents Are....

– short-term, liquid investments convertible into cash with little delay,

– money market accounts,

– Government bills (debentures).


Basic Organization of theCash Flow Statement

A business may be evaluated in terms of three types of business activities:

1. Operating activities.

2. Investing activities.

3. Financing activities.


Operating Activities

Operating activities are related to thetransactions that make up net profit.Operating activities are related to thetransactions that make up net profit.

Interest and dividends received arerelated to financing activities.

Interest and dividends received arerelated to financing activities.

However, we classify the cash received from these items as operating activities.However, we classify the cash received from these items as operating activities.


Investing activities increase and decreasethe assets that are available to the business.

Investing activities increase and decreasethe assets that are available to the business.

Investing Activities

Investing activities are related to theLong-term (Non-current) Asset accounts.

Investing activities are related to theLong-term (Non-current) Asset accounts.


These are transactions involving obtainingresources from the owners or returning resources to them (share buy-backs and paying dividends to your shareholders).

These are transactions involving obtainingresources from the owners or returning resources to them (share buy-backs and paying dividends to your shareholders).

Financing Activities

It also involves obtaining resources from long-term liabilities – creditors and

repaying the amount borrowed (but payinginterest is considered operating.. because?).

It also involves obtaining resources from long-term liabilities – creditors and

repaying the amount borrowed (but payinginterest is considered operating.. because?).


Format of the Cash Flow Statement

The direct method lists cash receipts from specific operating activities and cash payments for each major operating activity. It is required by AASB 107 Cash Flow Statements.

The indirect method uses accruals to adjust profits to calculate cash flow.


Cash flows from operating activities:Receipts:Collections from customers $271Interest received on bills receivable 10Dividends received on investments in shares 9Total receipts $290

Cash Flow Statement (Direct Method)Year Ended June 30, 2007 (Thousands $)

The Direct Method(Exhibit 18-5 p687)


Payments:To suppliers $133To employees 58For interest 16For income tax 15Total payments 222Net cash inflows from operating activities $ 68

The Direct Method

Cash Flow Statement (Direct Method)Year Ended June 30, 2007


Cash flows from investing activities:Acquisition of non-current assets $(306)Loan to another company (11)Proceeds from sale of non-current assets 62Net cash outflow frominvesting activities $(255)

The Direct Method



Cash flows from financing activities:Proceeds from issue of ordinary shares $101Proceeds from issue of debentures 94Payment of long-term bills payable (11)Payment of dividends (17)Net cash inflow from financing activities $167

The Direct Method



Net cash inflows from operating activities $ 68Net Cash outflow from investing activities (255)Net Cash inflow from financing activities 167Net (decrease in cash) $(20)Cash balance, June 30, 2006 42Cash balance, June 30, 2007 $ 22

The Direct Method



Revenues or expenses from the Income Statement

+ –

Adjusted for the change in the related Balance Sheet account(s)

Amount for the Cash Flow Statement

=

Calculate Individual Amounts for the Cash Flow Statement


Revenues and gains:Sales revenue $284Interest revenue 12Dividend revenue 9Gain on sale of plant assets 8Total revenues and gains $313


Income StatementYear Ended June 30, 2007 (Thousands $)

(Exhibit 18-6)


Expenses:Cost of goods sold $150Salary expense 56Depreciation expense 18Interest expense 16Other operating expense 17Total expenses $257



Total revenues and gains $313Less total expenses 257Net profits before tax 56Less income tax expense 15Net profit after tax $ 41


Income StatementYear Ended June 30, 2007 (Thousands)


Assets 2007 2006 Inc./(Dec.)Current:Cash $ 22 $ 42 $ (20)Accounts receivable 93 80 13Interest receivable 3 1 2Inventory 135 138 (3)Prepaid expenses 8 7 1Long-term receivable 11 – 11Plant, etc net 453 219 234Total assets $725 $487 $238

Comparative Balance Sheets(Exhibit 18-7)


Liabilities 2007 2006 Inc./(Dec.)Current:Accounts payable $ 91 $ 57 $ 34Salary payable 4 6 (2)Accrued liabilities 1 3 (2)Long-term bills payable 160 77 83Shareholders’ equity:Ordinary shares 359 258 101Retained earnings 110 86 24Total liabilities andshareholders’ equity $725 $487 $238

Comparative Balance Sheets


Calculating Cash Collectionsfrom Customers

Collections can be calculated by converting sales revenue to the cash basis.

Beginning Accounts Receivable balance + Sales on account – Collections = Ending Accounts Receivable balance.


Calculating Cash Collectionsfrom Customers

$80,000 + $284,000 – 93,000 = $271,000

Because Accounts Receivable increased by $13,000, the business received $13,000 less cash than its sales revenue for the period.

All collections of receivables are calculated following the pattern illustrated for collections from customers.


Calculating Paymentsto Suppliers

This calculation includes two parts, payments for inventory and payments for expenses other than interest and income tax.Payments for inventory are calculated by converting cost of goods sold to the cash basis.This is accomplished by analysing the Inventory and Accounts Payable accounts.


Payments for Inventory

Inventory

Beg. inventory 138,000

Purchases X

Cost of goods sold 150,000

End. inventory 135,000



How much were the purchases?

$138,000 + X – $150,000 = $135,000

X = $135,000 – $138,000 + $150,000

X = $147,000



Accounts Payable

Payments forinventory Y

Beg. balance 57,000

End. balance 91,000

Purchases 147,000



How much did the business pay for this inventory?

$57,000 + $147,000 – Y = $91,000

Y = $57,000 + $147,000 – $91,000

Y = $113,000


Payments for Operating Expenses

Increases in prepaid expenses require cash payments, and decreases indicate that payments were less than expenses.

Decreases in accrued liabilities can occur only from cash payments, and increases mean that cash was not paid.


Payments to Employees

Salary Payable was $6,000 at the beginning of the year and $4,000 at year end.

During the year Salary and Wages Expense was $56,000.

How much did the business pay?

$58,000.

Because the liability decreased so we not only paid the expense but also $2,000 off the liability.


Investing Activities

Acquisition and Sales of Non-Current AssetsThe business had non-current assets net of depreciation of $219,000 at the beginning of the year and $453,000 at year end.Further, the acquisition of non-current assets amounted to $306,000 during the year.


Acquisition and Salesof Non-current Assets

The income statement shows depreciation expense of $18,000 and a $8,000 gain on sale of plant assets.

What is the book value of the assets sold?

Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance.



$219,000 + $306,000 – $18,000 – Z = $453,000

Z = $219,000 + $306,000 – $18,000 – $453,000

Z = $54,000 (book value)

How much are the proceeds from the sale of plant assets?



Book value + Gain or – Loss = Proceeds.

$54,000 + $8,000 = $62,000.

How do we determine acquisitions?

Beginning net balance + Acquisitions – Depreciation – Book value of assets sold = Ending balance.


Calculating the Cash Amountsof Financing Activities

Financing activities affect liability and stockholders’ equity accounts:

– Bills Payable,

– Debentures Payable,

– Long-Term Debt,

– Share Capital;– Dividends,

– Retained Earnings.


Issue and Payments ofLong-Term Bills Payable

Beginning balance was $77,000.

New debt amounting to $94,000 was issued during the year.

The ending balance for the Long-Term Bills Payable account was $160,000.

How much was the payment?

$11,000.


Issue and Buy-back of Shares

Beginning balance was $258,000.

New shares issued during the year $101,000.

Minus any buy-backs (in this case zero).

Equals the closing balance.


Calculating Dividend Payments

Dividend payments are calculated by analysing the Dividends Payable account.

Beginning balance + Dividends declared – Dividend payments = Ending balance.


Format of the Cash Flow Statement

AASB 107 requires cash flow statements to be prepared by the direct method.

So why do we look at the indirect method?

1. Aids our understanding of cash flows.

2. The information calculated using the indirect method is required to be disclosed as supplementary information.


Current Assets

Add to Net Profit if this account has decreased

The Indirect Method

Deduct from Net Profit if this account has increased


Current Liabilities

Add to Net Profit if this account has increased

The Indirect Method

Deduct from Net Profit if this account has decreased


Cash Flow Statement (Indirect Method)Year Ended June 30, 2007 (Thousands $)

Cash flows from operating activities:Net Profit $41Add (deduct) items that affect net profitsand cash flows differently:Depreciation 18Gain on sale of non-current 8Increase in accounts receivable (13)Increase in interest receivable (2)Decrease in inventory 3

The Indirect Method(Exhibit 18-12)


Add (deduct) items that affect net profitand cash flows differently:Increase in prepaid expenses (1)Increase in accounts payable 34Decrease in salary payable (2)Decrease in accrued liabilities (2)Net cash inflow from operating activities $ 68

The Indirect Method

Cash Flow Statement (Indirect Method)Year Ended June 30, 2007 (Thousands)


An Explanation

Assume cash flow from operations was the same as net profit except for depreciation.

Depreciation is a non-cash expense.

Depreciation reduces profits but not cash flow from operations.

To get from net profits to cash flow you need to add (or add back) depreciation to profits to get cash flow.


Reconciling Net Profitto Net Cash Flow

AASB 107 requires companies to use the direct method and to report a reconciliation of net profits to cash flow from operations.

The reconciliation format is similar to the operating section of the cash flow statement prepared using the indirect method.


Non-cash Financing andInvesting Activities...

– are not reported in the body of the cash flow statement.

AASB 107 requires that significant non-cash investing and financing activities be disclosed in the notes or in a separate schedule at the bottom of the statement.


Using Cash Flow Information

Cash flows are important to a company’s survival.Investors and creditors want to make predictions about net profit and future cash flows.Without cash from operations a business cannot survive.Why – no one will lend or invest if long-term a company cannot generate cash from operations.


The Bank Account as a Control Device

Documents used to control a bank account include:

– signature card

– deposit slip

– cheque

– bank statement

– bank reconciliation


The Bank Reconciliation

What are the two records of a business’ cash?

1. Cash account in the business’s own general ledger.

2. The bank statement which tells the actual amount of cash the business has in the bank.



Items recorded by a company not on the bank statement:

– deposit in transit

– outstanding cheques



Items on a bank statement and not recorded by the business:

– bank collections

– bank fees

– interest earned or paid on account– NSF cheques (bounced cheques)


A Cheque’s Path (Good Cheque)

Makerwrites cheque

to payee.

Makerwrites cheque

to payee.Payee

deposits chequein bank.

Payeedeposits cheque

in bank.Payee’s bank

sends cheque tomaker’s bank.

Payee’s banksends cheque tomaker’s bank.

Maker’s bankpays the cheque.

Maker’s bankpays the cheque.


A Cheque’s Path (Dishonoured Cheque)

Maker’s bankbalance is notsufficient to

pay the cheque.

Maker’s bankbalance is notsufficient to

pay the cheque.Maker’s banksends theworthless

cheque back topayee’s bank.

Maker’s banksends theworthless

cheque back topayee’s bank. Payee’s bank

decreases payee’sbalance.

Payee’s bankdecreases payee’s

balance.

Payee holdsworthlesscheque.

Payee holdsworthlesscheque.


The Bank Reconciliation Example

At the beginning of July, Tran Limited, received June’s bank statement.

It indicated the following:

The bank balance was $63,275.

The bank had collected a note receivable from one of Tran’s customers for the amount of $1,325.



The bank paid the electric bill of $1,500.

There was a $200 cheque returned for NSF.

Interest earned on the account was $265.

Bank service charges were $12.



Tran’s books indicate a cash balance of $66,647.

A deposit of $11,250 was mailed to the bank on June 30.

Cheques issued in June for $8,000 have not yet been paid by the bank.


Balance per bank, June 30 $63,275

Add deposit in transit 11,250$74,525

Less outstanding cheque 8,000Adjusted bank balance $66,525

Balance per bank, June 30 $63,275

Add deposit in transit 11,250$74,525

Less outstanding cheque 8,000Adjusted bank balance $66,525



Balance per books, June 30 $66,647Add: Note receivablecollected by the bank 1,325Interest revenue 265

$68,237Less: Payment of electric bill 1,500NSF cheque 200Service charge 12Adjusted book balance $ 66,525

Balance per books, June 30 $66,647Add: Note receivablecollected by the bank 1,325Interest revenue 265

$68,237Less: Payment of electric bill 1,500NSF cheque 200Service charge 12Adjusted book balance $ 66,525




Balance per books$66,525

Balance per books$66,525

Balance per bank$66,525

Balance per bank$66,525

Equal amountsEqual amounts


Record Reconciling Items

June 30, 2007Cash 1,325

Bills Receivable 1,325 Bill collected by the bank

June 30, 2007Cash 1,325

Bills Receivable 1,325 Bill collected by the bank

June 30, 2007Cash 265

Interest Revenue 265 Interest earned on bank balance

June 30, 2007Cash 265

Interest Revenue 265 Interest earned on bank balance



June 30, 2007Electricity Expense 1,500

Cash 1,500Monthly electricity expense

June 30, 2007Electricity Expense 1,500

Cash 1,500Monthly electricity expense

June 30, 2007Accounts Receivable – NSF 200

Cash 200NSF cheque returned by bank

June 30, 2007Accounts Receivable – NSF 200

Cash 200NSF cheque returned by bank



June 30, 2007Bank Service Fees 12

Cash 12

Bank service charges

June 30, 2007Bank Service Fees 12

Cash 12

Bank service charges

cash flow statement

Documents

cash cash balance

cash payments

hand cash

cash effects

cash flow statement30606

cash flow statements

cash flow statementobjectives2

net cash inflows