financial accounting and accounting standards chapter 13 statement of cash flows learning objectives...

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Chapter 13 Statement of Cash Flows

Learning Objectives

After studying this chapter, you should be able to:

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

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

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

4. Analyze the statement of cash flows.

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Preview of Chapter 13

Financial Accounting

IFRS Second Edition

Weygandt Kimmel Kieso

13-4 LO 1 Indicate the usefulness 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.

Usefulness of the Statement of Cash Flows

Usefulness and Format

13-5

Classification of Cash Flows

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

Income

Statement Items

Operating

Activities

Changes in

Investments and

Non-Current

Asset

Investing

Activities

Changes in

Non-Current

Liabilities and

Equity

Financing

Activities


13-6 LO 2 Distinguish among operating, investing, and financing activities.


Classification of Cash Flows Illustration 13-1

Typical receipt and

payment classifications



Classification of Cash Flows Illustration 13-1

Typical receipt and

payment classifications

13-8

1. Direct issuance of ordinary shares to purchase assets.

2. Conversion of bonds into ordinary shares.

3. Direct issuance of debt to purchase assets.

4. Exchanges of plant assets.

Companies report non-cash activities in either a

separate note or

supplementary schedule to the financial statements.


Significant Non-Cash Activities


13-10

Order of Presentation:

1. Operating activities.

2. Investing activities.

3. Financing activities.

Direct Method

Indirect Method


Format of the Statement of Cash Flows



Illustration 13-3

Format of the Statement of Cash Flows

13-12

Illustration: Classify each of these transactions by type of cash

flow activity.


1. Issued 100,000 shares of HK$50 par value ordinary

shares for HK$800,000 cash.

2. Borrowed HK$2,000,000 from Castle Bank, signing

a 5-year note bearing 8% interest.

3. Purchased two semi-trailer trucks for HK$1,700,000

cash.

4. Paid employees HK$120,000 for salaries and

wages.

5. Collected HK$200,000 cash for services provided.

Financing

Financing

Investing

Operating

Operating

13-13

Three Sources of Information:

1. Comparative statements of financial position

2. Current income statement

3. Additional information

Preparing the Statement of Cash Flows



13-14

Three Major Steps: Illustration 13-4




13-15



Three Major Steps: Illustration 13-4

13-16

Indirect and Direct Methods



Companies favor the indirect method for two reasons:

1. Easier and less costly to prepare, and

2. Focuses on the differences between net income and net

cash flow from operating activities.

13-17 LO 3 Prepare a statement of cash flows using the indirect method.

Illustration – Indirect Method Illustration 13-5



Illustration 13-5


13-19 LO 3

Additional information for 2014:

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 ordinary shares for €20,000 cash.

6. The company declared and paid a €29,000 cash dividend.


Illustration 13-5

13-20

Step 1: Operating Activities

Determine net cash provided/used by operating activities by

converting net income from accrual basis to cash basis.

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

Common adjustments to Net Income (Loss):

Add back non-cash expenses (depreciation, amortization,

or depletion expense).

Deduct gains and add losses.

Changes in non-cash current asset and current liability

accounts.


13-21

Depreciation Expense

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 13-7


13-22

Loss on Disposal of Plant Assets

Companies should report cash received from the sale

(disposal) of plant assets in the investing activities section.

Because of this,

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.









Loss on disposal of plant assets 3,000


Illustration 13-8


Loss on Disposal of Plant Assets

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Changes to Non-Cash Current Asset Accounts

When the Accounts Receivable balance decreases, cash

receipts are higher than revenue earned under the accrual

basis.


Company adds to net income the amount of the decrease in

accounts receivable.

Accounts Receivable

1/1/014 Balance 30,000

Sales revenue 507,000

Receipts from customers 517,000

12/31/14 Balance 20,000

Illustration 13-9









Decrease in accounts receivable 10,000


Illustration 13-10



13-26

When the Inventory balance increases, the cost of

merchandise purchased exceeds the cost of goods sold.



Inventory

1/1/14 Balance 10,000

Purchases 155,000

Cost of goods sold 150,000

12/31/14 Balance 15,000

Cost of goods sold does not reflect cash payments made for

merchandise. The company deducts from net income this

inventory increase.










Increase in inventory (5,000)



Illustration 13-10


13-28

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.













Increase in prepaid expenses (4,000)



Illustration 13-10


13-30

Changes to Non-Cash Current Liability Accounts

When Accounts Payable increases, 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 Taxes Payable decreases, 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.



13-31










Increase in accounts payable 16,000

Decrease in income taxes payable (2,000)


Illustration 13-11

LO 3


Changes to Non-Cash Current Liability Accounts

13-32 LO 3

Illustration 13-12

Summary of Conversion to Net Cash Provided

by Operating Activities—Indirect Method


13-34

Company purchased land of €110,000 by issuing long-term

bonds. This is a significant non-cash investing and financing

activity that merits disclosure in a separate schedule.


Land

1/1/14 Balance 20,000

Issued bonds 110,000

12/31/14 Balance 130,000

Bonds Payable

1/1/14 Balance 20,000

For land 110,000

12/31/14 Balance 130,000

Step 2: Investing and Financing Activities

13-35

Net cash provided by operating activities 172,000

Cash flows from investing activities:

Purchase of building (120,000)

Purchase of equipment (25,000)

Disposal of plant assets 4,000

Net cash used by investing activities (141,000)

Cash flows from financing activities:

Issuance of ordinary shares 20,000

Payment of cash dividends (29,000)

Net cash used by financing activities (9,000)

Net increase in cash 22,000

Cash at beginning of period 33,000

Cash at end of period € 55,000

Disclosure: Issuance of bonds to purchase land € 110,000

Illustration 13-14 Partial statement

LO 3


13-36

From the additional information, the company acquired an

office building for €120,000 cash. This is a cash outflow

reported in the investing section.


1/1/14 Balance 40,000

Office building 120,000

12/31/14 Balance 160,000

Building


13-37















LO 3



13-38

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.


1/1/14 Balance 10,000

Purchase 25,000

12/31/14 Balance 27,000

Cost of equipment sold 8,000

Cash 4,000

Accumulated depreciation 1,000


Equipment 8,000

Journal

Entry

Equipment


Illustration 13-12

13-39

























LO 3

Statement

of Cash

Flows

Illustration 13-14

Indirect

Method

13-40

The increase in ordinary shares resulted from the issuance of

new shares.


1/1/14 Balance 50,000

Shares sold 20,000

12/31/14 Balance 70,000

Share Capital - Ordinary


13-41
















LO 3


13-42

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.


1/1/14 Balance 48,000

Net income 145,000

12/31/14 Balance 164,000

Dividends 29,000

Retained Earnings


13-43

























Illustration 13-14

LO 3

Indirect

Method

Statement

of Cash

Flows

13-44

Illustration 13-5

Compare The Net Change In Cash On The Statement Of Cash Flows With

The Change In The Cash Account Reported On The Statement Of

Financial Positions To Make Sure The Amounts Agree.


Step 3: Net Change in Cash

13-46

Free Cash Flow

Free cash flow describes the cash remaining from operations

after adjustment for capital expenditures and dividends.

LO 4 Analyze the statement of cash flows.

Illustration 13-15

Using Cash Flows to Evaluate a Company

13-47

€4,189

Illustration 13-16

Less: Expenditures on property and equipment 1,794

Dividends paid 2,088

€307

Illustration

Required:

Calculate free

cash flow.

Using Cash Flows to Evaluate a Company

LO 4 Analyze the statement of cash flows.

Cash provided by operating activities

Free cash flow

13-48

Using a

Worksheet to

Prepare the

Statement of Cash

Flows-Indirect

Method

Illustration 13A-1

LO 5

APPENDIX 13A USING A WORKSHEET – INDIRECT METHOD

13-49

1. Enter in the statement of financial position accounts section the

statement of financial position accounts and their beginning and

ending balances.

2. Enter in the reconciling columns of the worksheet the data that

explain the changes in the statement of financial position

accounts other than cash and their effects on the statement of

cash flows.

3. Enter on the cash line and at the bottom of the worksheet the

increase or decrease in cash. This entry should enable the

totals of the reconciling columns to be in agreement.

LO 5 Explain how to use a worksheet to prepare the

statement of cash flows using the indirect method.

Preparing a Worksheet

APPENDIX 13A USING A WORKSHEET – INDIRECT METHOD

13-50

Using a Worksheet

to Prepare the

Statement of Cash

Flows-Indirect

Method

Illustration 13A-3

Completed worksheet—

indirect method

LO 5

APPENDIX 13A

13-51

1. Compute net cash provided by operating activities by

adjusting each item in the income statement from the

accrual basis to the cash basis.

2. Companies report only major classes of operating cash

receipts and cash payments.

3. For these major classes, the difference between cash

receipts and cash payments is the net cash provided by

operating activities.

Statement of Cash Flows-Direct Method

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

APPENDIX 13B STATEMENT OF CASH FLOWS – DIRECT METHOD

13-52

Illustration 13B-2

LO 6



13-53

Illustration 13B-1


LO 6

13-54



Illustration 13B-1

13-55 LO 6


Illustration 13B-1

13-56

Illustration 13B-4

Cash Receipts from Customers


For Computer Services Company, accounts receivable decreased

€10,000.

Illustration 13B-5


13-57

Illustration 13B-6

Cash Payments to Suppliers

Illustration 13B-9

Illustration 13B-7



In 2014, Computer Services Company’s inventory increased €5,000

and cash payments to suppliers were €139,000.

13-58

Illustration 13B-10

Cash Payments for Operating Expenses

Cash payments for operating expenses were €115,000.

Illustration 13B-11



13-59

Cash Payments for Income Taxes

Cash payments for income taxes were €49,000.



Illustration 13B-12

Illustration 13B-13

13-60

Step 1:

Operating

Activities

Illustration 13B-16


13-61

Increase in Equipment. (1) Computer Services purchased for

cash equipment costing €25,000. And (2) it sold for €4,000 cash

equipment costing €8,000, whose book value was €7,000.




Illustration 13B-15

13-62

Increase in Building. From the additional information, the

company acquired an office building for €120,000 cash. This is a

cash outflow reported in the investing section.




1/1/14 Balance 40,000

Office building 120,000

12/31/14 Balance 160,000

Building

13-63

Increase in Land. Computer Services

purchased land of €110,000 by directly

exchanging bonds for land.

Significant non-cash

investing and financing

transaction.

Increase in Bonds Payable. Bonds

Payable increased €110,000. The

additional information indicated that

Computer Services issued €110,000 of

long-term bonds in direct exchange for

land.




Significant non-cash

investing and financing

transaction.

13-64

Increase in Share Capital - Ordinary.

The Share Capital - Ordinary account

increased €20,000. The additional

information indicated that Computer

Services issued ordinary shares for cash.

Increase in Retained Earnings. The

€116,000 net increase in Retained

Earnings resulted from net income of

€145,000 and the declaration and

payment of a cash dividend

of €29,000.

Financing activity (cash

dividend).

Financing activity.




13-65

Step 2:

Investing

and

Financing

Activities

Illustration 13B-16


13-66

Compare the net change in cash on the Statement of Cash Flows

with the change in the cash account reported on the Statement of

Financial Position to make sure the amounts agree.

Step 3: Net Change in Cash



13-67

APPENDIX 13C T-ACCOUNT APPROACH

What this means is that the change in cash is equal to the

change in all of the other statement of financial position

accounts.

Another way to think about this is that if we analyze the

changes in all of the non-cash statement of financial position

accounts, we will explain the change in the cash account.

13-68

Illustration 13C-1

APPENDIX

13C

13-69

Key Points

Companies preparing financial statements under both GAAP and

IFRS must 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

should have three major sections—operating, investing, and

financing—along with changes in cash and cash equivalents.

Similar to IFRS, the statement of cash flows can be prepared using

either the indirect or direct method under GAAP. Companies choose

for the most part to use the indirect method for reporting net cash

flows from operating activities.

Another Perspective

13-70

Key Points

The definition of cash equivalents used in GAAP is similar to that

used in IFRS. 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 GAAP). Under GAAP, bank overdrafts

are classified as financing activities in the statement of cash flows

and are reported as liabilities on the statement of financial position.

IFRS requires that non-cash investing and financing activities be

excluded from the statement of cash flows. Instead, these non-cash

activities should be reported elsewhere. This requirement is

interpreted to mean that non-cash investing and financing activities

should be disclosed in the notes to the financial statements instead

of in the financial statements. Under GAAP, companies may present

this information on the face of the statement of cash flows.

Another Perspective

13-71

Key Points

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.

Another Perspective

13-72

Key Points

Under IFRS, some companies present 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.

Similar to IFRS, under GAAP companies must disclose the amount

of taxes and interest paid. Under GAAP, companies disclose this in

the notes to the financial statements. Under IFRS, some companies

disclose this information in the notes, but others provide individual

line items on the face of the statement. In order to provide this

information on the face of the statement, companies first add back

the amount of interest expense and tax expense (similar to adding

back depreciation expense) and then further down the statement

they subtract the cash amount paid for interest and taxes.

Another Perspective

13-73

Looking to the Future

Presently, the FASB and the IASB are involved in a joint project on the presentation

and organization of information in the financial statements. One interesting approach,

revealed in a published proposal from that project, is that in the future the income

statement and statement of financial position (balance sheet) would adopt headings

similar to those of the statement of cash flows. That is, the income statement and

statement of financial position would be broken into operating, investing, and

financing sections.

With respect to the cash flow statement specifically, the notion of cash equivalents

will probably not be retained. That is, cash equivalents will not be combined with cash

but instead will be reported as a form of highly liquid, low-risk investment. The

definition of cash in the existing literature would be retained, and the statement of

cash flows would present information on changes in cash only. In addition, the FASB

favors presentation of operating cash flows using the direct method only. However,

the majority of IASB members express a preference for not requiring use of the direct

method of reporting operating cash flows.

Another Perspective

13-74

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