ch_05 statement of cash flows

8/12/2019 Ch_05 Statement of Cash Flows

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2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick

Statement of

Cash Flows

CHAPTER

5


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2006 Prentice Hall Business Publishing Introduction to Financial Accounting, 9/e Horngren/Sundem/Elliott/Philbrick 2 of 26

Learning Objectives

After studying this chapter, you should be able to

1. Identify the purposes of the statement of cash flows

2. Classify activities affecting cash as operating,

investing, or financing activities3. Compute and interpret cash flows from financing

activities

4. Compute and interpret cash flows from investing

activities5. Use the direct method to calculate cash flows from

operations


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Learning Objectives

After studying this chapter, you should be able to

6. Use the indirect method to explain the differencebetween net income and net cash provided by

(used for) operating activities7. Understand why depreciation is added to net

income when using the indirect method forcomputing cash flow from operating activities

8. Show how the balance sheet equation provides aconceptual framework for the statement of cashflows


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Overview

The purpose of the statement of cash flowsisto

Report cash receipts and cash payments of an entity

over a period of time Classify the cash flows as operating, investing, and

financing activities

Detail the changes in the cash account on the

balance sheet


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Overview

Balance Sheet

December 31,

20X0

Balance Sheet

December 31,

20X1

Statement of Income

Statement of Cash Flows


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Purpose of the Cash Flow Statement

A statement of cash flows

Shows the relationship of net income to changes incash balances

Helps to predict future cash flows Evaluates how management generates and uses

cash

Determines a companys ability to pay interest,

dividends, and debts when they are due Identifies specific increases and decreases in a firms

productive assets


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Purpose of the Cash Flow Statement

The term cash also refers to cash equivalents

Cash equivalentsare highly liquid short-terminvestments that a company can easily and

quickly convert into cash

Money market funds

Treasury bills



Typical Activities Affecting Cash

Managers affect cash by three types ofdecisions:

Operating decisions

Financing decisions Investing decisions

Operating decisionsare concerned with the

major day-to-day activities that generaterevenues and expenses




Operating activitiesare transactions that affectthe purchase, processing, and selling of acompanys products and services

Making sales Collecting accounts receivable

Purchasing inventory

Paying accounts payable

The first major section of the statement of cashflows is labeled cash flows from operatingactivities




Financing decisionsare concerned with how toobtain or repay cash

Financing activitiesare a companys

transactions that obtain resources from debt andequity transactions

Issuance of additional stock

Borrowing money from the bank

Repaying previous loans The financing section on the statement is

labeled cash flows from financing activities




Investing decisionsinclude the choices toacquire or dispose of long-term productiveassets or long-term investments

Investing activitiesare transactions thatacquire or dispose of assets that are expected toprovide services for more than one year

Purchasing or disposing of equipment The investing section on the statement is labeled

cash flows from investing activities




Cash Inflows Cash Outflows

Operating Activities:Collections from customers Cash payments to suppliersInterest and dividends collected Cash payments to employeesOther operating receipts Interest and taxes paid

Other operating cash payments

Investing Activities:Sale of property, plant, and equipment Purchase of property, plant, and equipmentSale of securities that are not Purchase of securities that are not

cash equivalents cash equivalentsReceipt of loan repayments Making loans

Financing:Borrowing cash from creditors Repayment of amounts borrowedIssuing equity securities Repurchase of equity shares (including theIssuing debt securities purchase of treasury stock)

Payment of dividends



Preparing the


The following two slides for Biwheels Companyshow the:

Changes in the balance sheet equation (transactions)

during the first month of operations Income statement for the first month of operations

and the January 31 balance sheet

Notice that the cash balance increased from $0

to $351,000 during the month



Preparing the

Statement of Cash FlowsAssets = Liabili ties + Stockholders' Equity

Description of Transactions Cash +

Accounts

Receivable +

Merchandise

Inventory +

Prepaid

Rent +

Store

Equipment =

Note

Payable +

Accounts

Payable +

Paid-in

Capital +

Retained

Earnings

(1) Initial investment +400,000 = +400,000

(2) Loan from bank +100,000 = +100,000

(3) Acquire s tore equipment

for cash -15,000 +15,000 =

(4) Acquire inventory for cash -120,000 +120,000 =

(5) Acquire inventory on credit +10,000 = +10,000

(6) Acquire inventory for cashplus credit -10,000 +30,000 = +20,000

(7) Sales of equipment +1,000 -1,000 =

(8) Return of inventory

acquired on January 5 -800 = -800

(9) Payments to creditors -4,000 = -4,000

(10a) Sales on open account +160,000 = +160,000

(10b) Cost of merchandise

inventory sold -100,000 = -100,000

(11) Collect accounts

receibable +5,000 -5,000 =

(12) Pay rent in advance -6,000 +6,000 =

(13) Recognize expiration of

rental services -2,000 = -2,000

(14) Depreciation -100 = -100

Balance January 31, 20X2 351,000 +155,000 +59,200 +4,000 +13,900 = 100,000 +25,200 +400,000 +57,900

583,100 583,100



Preparing the


Biwheels CompanyIncome Statement

For the Month Ended January 31, 20X2

Sales (revenues) $160,000Deduct expenses:

Cost of goods sold $100,000Rent 2,000

Depreciation 100Total expenses 102,100

Net income $ 57,900

Balance Sheet, January 31, 20X2

Assets Liabilities and Stockholders EquityCash $351,000 Liabilities

Accounts receivable 155,000 Note payable $100,000Merchandise inventory 59,200 Accounts payable 25,200

Prepaid rent 4,000 Total liabilities $125,000Store equipment 13,900 Stockholders equity

Paid-in capital $400,000Retained earnings 57,900Total stockholders equity 457,900

Total liabilities andTotal assets $583.100 stockholders equity $583,100



Cash Flows from

Financing Activities

Two general rules apply for identifying financingactivities:

Increases in cash (cash inflows) stem from increases

in long-term liabilities or paid-in capital Decreases in cash (cash outflows) stem from

decreases in long-term liabilities or paid-in capital

Biwheels had two such transactions in January:

Transaction 1: Initial investment, $400,000

Transaction 2: Loan from bank, $500,000



Cash Flows from

Investing Activities

Two general rules apply for identifying investingactivities:

Increases in cash (cash inflows) from decreases in

long-lived assets, loans, and investments Decreases in cash (cash outflows) stem fromincreases in long-lived assets, loans, and investments

There were two such transactions relating tostore equipment in January:

Transaction 3: Acquire store equipment for cash,$15,000

Transaction 7: Sale of store equipment for cash,$1,000



Noncash Investing and

Financing Activities

Sometimes financing and investing activities donot affect cash

Example: If Biwheels acquires $8,000 of store

equipment by issuing common stock

The purchase of store equipment is an investingactivity

The issuance of common stock is a financing activity Companies must report such items in a schedule

of noncash investing and financing activities



Cash Flow from Operating Activities

Direct method:

Subtracts operating cashdisbursements fromoperating cash collections

Is preferred by the FASB

Indirect method:

Adjusts accrual-based netincome from the incomestatement to reflect onlycash receipts anddisbursements

Is used by most U.S.companies

Two approaches may be used:



The Direct Method

Examining the cash column of Biwheels balancesheet equation, transactions 1, 2, 3, and 7 arefinancing and investing activities

The remaining transactions must be operating

activities:

Biwheels CompanyCash Flows from Operating ActivitiesDirect Method

For the Month of January 20X2

Cash payments for inventory (transactions 4 and 6) $(130,000)Cash payments to creditors for accounts payable (transaction 9) (4,000)Cash collections on accounts receivable (transaction 11) 5,000Cash payments for rent (transaction 12) 6,000Net cash used by operating activities $(135,000)



The Indirect Method

When the cash flow from a sale or outflow froman expense occurs in one accounting period andthe revenue or expense occurs in another, net

income differs from cash flows from operations The indirect method highlights these differences

by starting with net income, and adjusts it tocash flows from operating activities

Example: Depreciation is added back to netincome because it is a noncash expense



The Indirect Method

Net income

Adjust for revenues and expenses not requiring cash

Add back depreciation

Other adjustments Adjust for changes in noncash assets and liabilities

relating to operating activities

Add decreases in assets

Deduct increases in assets

Add increases in liabilities

Deduct decreases in liabilities



The Indirect Method

Biwheels CompanyCash Flows from operating ActivitiesIndirect Method


Net income $ 57,900

Adjustments to reconcile net income tonet cash provided by operating activities:Depreciation 100Net increase in accounts receivable (155,000)Net increase in inventory (59,200)Net increase in accounts payable 25,200Net increase in rent payable (4,000)

Net cash provided by operating activities $(135,000)



Reconciliation Statement

The FASB requires direct-method statements toinclude a supplementary schedule reconcilingnet income to net cash provided by operations

In other words, companies that use the directmethod must also prepare a report using theindirect method (reconciliation schedule)

As a result, most companies use the indirectmethod



Example of Statement of Cash Flows

Biwheels CompanyStatement of Cash Flows


Cash flows from operating activities:Net income $ 57,900Adjustments to reconcile net income to

net cash provided by operating activities:Depreciation 100Net increase in accounts receivable (155,000)Net increase in inventory (59,200)Net increase in accounts payable 25,200Net increase in rent payable (4,000)

Net cash provided by operating activities $(135,000)

Cash flows from investing activities:Purchase of store equipment $ (15,000)Proceeds from sale of store equipment 1,000Net cash provided by investing activities (14,000)

Cash flows from financing activities:Proceeds from initial investment $ 400,000Proceeds from issuance of common stock 100,000Net cash provided by financing activities 500,000

Net increase in cash 351,000Cash, January 2, 20X2 0Cash, January 31, 20X2 $351,000


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The Importance of Cash Flow

The income statement matches revenues andexpenses using accrual concepts and provides ameasure of economic performance

The statement of cash flows explains changes inthe cash account rather than owners equity

Free cash flow

Is a measure of cash management performance Refers to cash flows from operations less capital

expenditures (and sometimes less dividends)

ch_05 statement of cash flows

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