Statement of Cash Flows

Chapter 16

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Describe the cash flow activities reported in the statement of cash flows

Objective 1

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The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a company’s ability to do the following:

1. Generate cash from operations2. Maintain and expand its operating capacity3. Meet its financial obligations4. Pay dividends

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Reporting Cash FlowsThe statement of cash flows reports cash flows from three types of activities:1. Cash flows from operating activities are cash

flows from transactions that affect net income.2. Cash flows from investing activities are cash

flows from transactions that affect the investments in noncurrent assets of the company.

3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the company.

4

Cash FlowsExhibit 1

5

Cash Flows from Operating Activities

The direct method reports the sources of operating cash and the uses of operating cash.

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The indirect method reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash.

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The primary advantage of the indirect method is that it reconciles the difference between net income and net cash flows from operations. Also, the indirect method is less costly to use than the direct method.

If you use the direct method, you will need to provide a reconciliation—which is the indirect method.

Over 99% of companies use the indirect method.

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Cash Flows from Operations: Direct and Indirect Methods—NetSolutions

The same

Exhibit 2

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Cash Flows from Investing Activities

• Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.

• Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.

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• Cash inflows from financing activities normally arise from issuing debt or equity securities.

• Cash outflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock.

Cash Flows from Financing Activities

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Noncash investing and financing activities are transactions that do not directly affect cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows.

Noncash Investing and Financing Activities

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No Cash Flow Per Share

Cash flow per share should not be reported on a company’s financial statements for the following reasons:1. Users may misinterpret cash flow

per share as the per-share amount available for dividends.

2. Users may misinterpret cash flow per share as equivalent to earnings per share.

13

Identify whether each of the following would be reported as an operating, investing, or financing activity in the statement of cash flows.a. Purchase of patent d. Cash saleb. Payment of cash dividend e. Purchase of treasury

stockc. Disposal of equipment f. Payment of wages

expense

Example Exercise 16-1Classifying Cash Flows

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a. Purchase of patent d. Cash saleb. Payment of cash dividend e. Purchase of treasury

stockc. Disposal of equipment f. Payment of wages

expense

if

ifo

o

Example Exercise 16-1 (continued)

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

Objective 2

16

The indirect method of reporting cash flows from operating activities uses the logic that a change in any balance sheet account (including Cash) can be analyzed in terms of changes in other balance sheet accounts.

Efficient Approach

17

Income Statement and Comparative Balance Sheet

(continued)

Exhibit 3

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Income Statement and Comparative Balance Sheet (continued)Exhibit 3

19

The analysis of Retained Earnings provides a good starting point for determining the cash flows from operating activities.

Retained Earnings

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The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year.

The net income of $108,000 is the first amount reported in the Cash Flows from Operating Activities section.

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Cash flows from operating activities:Net income $108,000Adjustments to reconcile net income

to net cash flow from operating activities:

This phrase is added to indicate that accrual basis net income is being adjusted to arrive at cash flows from operations.

Adjustments to Net Income

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Adjustments to Net Income (Loss) Using the Indirect MethodExhibit 4

Step 1

Step 2Step 3

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Step 1Expenses that do not affect cash are added. Such expenses decreased net income, but did not involve cash payments and, thus, are added to net income. Examples include depreciation of fixed assets and amortization of intangible assets.

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Step 2Loses and gains on disposal of assets are added or deducted. The disposal (sale) of assets is an investing activity, rather than an operating activity. Losses on disposal of assets are added back to net income. Gains on disposal of assets are deducted from net income.

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Step 3Changes in current operating assets and liabilities are added or deducted as follows:• Increases in noncash current operating

assets are deducted.• Decreases in noncash current operating

assets are added.• Increases in current operating liabilities are

added.• Decreases in current operating liabilities

are deducted.

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Example Exercise 16-2

Adjustments to Net Income—Indirect Method

Omni Corporation’s accumulated depreciation increased by $12,000, while patents decreased by $3,400 between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from sale of land. Reconcile a net income of $50,000 to net cash flow from operating activities.

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Example Exercise 16-2 (continued)

Net income………………………………………. $50,000Adjustments to reconcile net income to net

cash flow from operating activities:Depreciation…………………………………. 12,000Amortization of patents………………………. 3,400Gain on sale of land………………………... (4,100)

Net cash flow from operating activities…….. $61,300

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Cash Flows from Operating Activities—Indirect Method

Step 2Step 1

Step 3

Exhibit 5

(continued on Slide 31)

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Step 1: The comparative balance sheets indicate that Accumulated Depreciation—Building increased by $7,000.

The account, shown below, indicates that Accumulated Depreciation—Building increased by $7,000.

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Step 1

Cash Flows from Operating Activities—Indirect Method (continued)Exhibit 5

(continued)

31

The proceeds, which included the gain, are reported in the Investing section of the statement of cash flows. Thus, the $12,000 is deducted from net income in determining cash flows from operating activities.

Step 2

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Cash Flows from Operating Activities—Indirect Method (continued)Exhibit 5

(continued)

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Next, select the current operating assets and liabilities that impact cash flows and determine their increases and decreases. Slide 35 may prove helpful.

Step 3

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Note that Cash and Dividends Payable are not included in this analysis.

Accounts receivable (net) $ 74,000 $ 65,000Inventories 172,000 180,000Accounts payable (mdse.) 43,500 46,700Accrued expenses payable 26,500 24,300Income taxes payable 7,900 8,400

9,0008,000*3,200*2,200500*

2010 2009 December 31 Increase

Decrease*

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Step 2Step 1

Step 3

Cash Flows from Operating Activities—Indirect Method (concluded)Exhibit 5

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Example Exercise 16-3

Changes in Current Operating Assets and Liabilities—Indirect MethodVictor Corporation’s comparative balance sheet for current assets and current liabilities was as follows:

Dec. 31, 2011 Dec. 31, 2010

Accounts receivable $ 6,500 $ 4,900Inventory 12,300 15,000Accounts payable 4,800 5,200Dividends payable 5,000 4,000

Adjust net income of $70,000 for changes in operating assets and liabilities to arrive at cash flows from operating activities.

37

Example Exercise 16-3 (continued)

Net income…………………………………………….. $70,000Adjustments to reconcile net income to net cash flow from operating activities:

Increase in accounts receivable………………. (1,600)Decrease in inventory…………………………... 2,700Decrease in accounts payable………………… (400)

Net cash flow from operating activities …..…..…. $70,700

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Example Exercise 16-4

Cash Flows from Operating Activities—Indirect MethodOmicron, Inc. reported the following data:

Prepare the cash flows for operating activities section of the statement of cash flows using the indirect method.

Net income $120,000Depreciation expense 12,000Loss on disposal of equipment 15,000Increase in Accounts receivable 5,000Decrease in Accounts payable (2,000)

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Example Exercise 16-4 (continued)

Cash flows from operating activities:Net income………………………………………..$120,000

Adjustments to reconcile net income to net cash flow from operating activities:

Depreciation………………………………….. 12,000Loss from disposal of equipment………... 15,000

Changes in current operating assets and liabilities:

Increase in accounts receivable………….. (5,000) Decrease in accounts payable…………….. (2,000)

Net cash flow from operating activities……... $140,000

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Dividends

Cash dividends of $28,000 were declared during 2010. Note the entry highlighted in yellow.

41

Only $24,000 of the dividends was paid in 2010.

Since dividend payments are a financing activity, the dividend payment is reported in the Financing Activities section.

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Common Stock

Rundell, Inc.’s Common Stock account increased by $8,000 during 2010.

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Paid-in Capital in Excess of Par—Common Stock increased $40,000 during the year.

Issuing company stock is a financing activity, so cash flows from financing activities increases by $48,000 ($8,000 + $40,000).

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Bonds PayableBonds Payable decreased $50,000 during 2010. A check with Rundell’s income statement show that there was no gain or loss on the retirement.

Retiring a bond payable is a financing activity, so a cash outflow of $50,000 is reported in the Financing Activities section of the statement of cash flows.

45

Building

The Building account increased by $60,000.

The cash outflow for this purchase is shown in the Financing Activities section of the statement.

46

Land

The $45,000 decline in the Land account was from two transactions.

47

Step 2

Earlier, as part of Step 2 in preparing the Operating Activities section, the $12,000 gain was deducted from net income.

The proceeds of $72,000 from the sale of land are reported in the Investing Activities section of the statement of cash flows.

48

The October 12 transaction is the purchase of land for cash of $15,000. This transaction is reported as an outflow of cash in the Cash Flows from Investing Activities section.

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Example Exercise 16-5

Land Transactions on the Statement of Cash FlowsAlpha Corporation purchased land for $125,000. Later in the year the company sold land with a book value of $165,000 for $200,000. How are the effects of these transactions reported on the statement of cash flows?

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Example Exercise 16-5 (continued)

The gain on sale of land is deducted from net income as shown below:

Cash received for sale of land…… $200,000Cash paid for purchase of land….. (125,000)

The purchase and sale of land is reported as part of cash inflow from investing activities as shown below:

Gain on sale of land………………..

$(35,000)

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payable

Statement of Cash Flows—Indirect Method

Exhibit 6

52

Prepare a statement of cash flows, using the direct method.

Objective 3

53

The final amount reported in the Cash Flows from Operating Activities section will be the same whether the direct or indirect approach is used. The methods differ in how the data are obtained, analyzed, and reported.

The Direct Method

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Cash Received from Customers

Rundell, Inc. reports sales of $1,180,000 for 2010. To determine the cash received from customers, sales are adjusted by any increase or decrease in accounts receivable.

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$(9,000)

$1,180,000 = $1,171,000

$0

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Cash Received from Customers—Direct MethodSales reported on the income statement were $350,000. The accounts receivable balance declined $8,000 over the year. Determine the amount of cash received from customers.

Example Exercise 16-6

Sales……………………………………………… $350,000Add decrease in accounts receivable……… 8,000Cash received from customers……………… $358,000

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Cash Payments for Merchandise

Rundell, Inc. reports cost of merchandise sold of $790,000. To determine the cash payment for merchandise, the $790,000 is adjusted for any increase or decrease in inventories and accounts payable (assuming the accounts payable are owed to merchandise suppliers).

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$(8,000)

$3,200

$790,000 = $785,200

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Cash Payment for Merchandise—Direct MethodCost of merchandise sold reported on the income statement was $145,000. The accounts payable balance increased $4,000, and the inventory balance increased by $9,000 over the year. Determine the amount of cash paid for merchandise.

Example Exercise 16-7

Cost of merchandise sold……………………… $145,000Add increase in inventory……………………… 9,000Deduct increase in accounts payable……….. (4,000)Cash paid for merchandise……………………. $150,000

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Cash Payments for Operating Expenses

Rundell, Inc. reports total operating expenses of $203,000, which includes depreciation expense of $7,000. To determine cash payments for operating expenses, the other operating expenses (excluding depreciation) of $196,000 are adjusted for any increase or decrease in accrued expenses payable.

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$196,000 = $193,800

$(2,200)

$0

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Interest ExpenseRundell, Inc. reports interest expense of 8,000. To determine the cash payments for interest, the $8,000 is adjusted for any increases or decreases in interest payable.

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$8,000 = $8,000

$0

$0

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Cash Payments for Income Taxes

Rundell, Inc. reports income tax expense of $83,000. To determine the cash payments for income taxes, the $83,000 is adjusted for any increases or decreases in income taxes payable.

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$83,000 = $83,500

$0

$500

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Statement of Cash Flows—Direct Method

(continued)

Exhibit 7

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Statement of Cash Flows—Direct Method (continued)Exhibit 7

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THE END

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