the statement of cash flows c hapter 22 copyright © 2010 south-western/cengage learning...

The Statement of Cash Flows

Chapter 22

COPYRIGHT © 2010 South-Western/Cengage Learning

Intermediate AccountingIntermediate Accounting 11th edition 11th edition

Nikolai Bazley JonesNikolai Bazley Jones

An electronic presentationAn electronic presentationBy Norman SundermanBy Norman Sundermanand Kenneth Buchananand Kenneth BuchananAngelo State University

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Cash Flow Statement

Cash is the lifeblood of any company and is critical to its

success. Cash flow information is used by both managers and

analysts to understand a company’s operations, assess its

liquidity, gain insight into its ability to invest in new assets, and

evaluate its financing decisions.

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1. A company’s ability to generate positive future net cash flows

2. A company’s ability to meet its obligations and pay dividends

3. A company’s need for external financing4. The reasons for differences between a company’s net

income and related cash receipts and payments5. Both the cash and noncash aspects of a company’s

financing and investing transactions during the accounting period

Purpose of a Cash Flow Statement

Helps users assess:Helps users assess:Helps users assess:Helps users assess:

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Operating ActivitiesOperating activities include transactions involving acquiring

(purchasing or manufacturing), selling, and delivering goods for sale, as well as providing services.

Inflows

Cash receipts from:• The sale of goods or services

• Collection of accounts receivable

• Collection of interest on loans

• Receipts of dividends on investments in equity securities

Outflows

Cash payments to:• Suppliers for inventory

• Employees

• The government for taxes

• Lenders for interest

• Other suppliers for various expenses

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Investing Activities

Investing activities include transactions involving acquiring and selling investments (both current and noncurrent), and

lending money and collecting on the loans.

Outflows

Cash payments for:• Acquiring property,

plant, and equipment

• Purchasing investments in other companies

• Making loans to borrowers

Inflows

Cash receipts from:• Sales of property,

plant, and equipment

• Sales of investments in other companies

• Principal repayments of loans by borrowers

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Financing ActivitiesFinancing activities include transactions involving obtaining resources

from owners and providing them with a return on, and of, their investment, as well as obtaining money and other resources from

creditors and repaying the amounts borrowed.

Inflows

Cash receipts from:• Issuing equity securities

• Issuing bonds

• Issuing mortgages

• Issuing notes

• Other short- or long-term borrowings

Outflows

Cash payments for:• Dividends

• Repurchase of the company’s equity securities

• Repayments of amounts borrowed

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Cash and Cash Equivalents

The cash flow statement is prepared using cash and cash equivalents.

Cash equivalents– Treasury bills– Commercial paper– Money market funds

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Inflows of Cash

1. Decreases in Assets Other than Cash. The sale or other disposal of assets (other than cash) causes an increase because cash is received in exchange for the assets.

2. Increases in Liabilities. The issuance or other incurrence of liabilities causes an increase in cash because cash is received in exchange for the liabilities.

3. Increases in Stockholders’ Equity. Net income and additional investments by owners result in an inflow of cash.

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Outflows of Cash

1. Increases in Assets Other than Cash. The acquisition of assets (other than cash) causes an decrease because cash is paid in exchange for the assets.

2. Decreases in Liabilities. The payment of liabilities causes an decrease in cash because cash is paid to satisfy the liabilities.

3. Decreases in Stockholders’ Equity. The payment of dividends and the acquisition of treasury stock are two common transactions that result in stockholders’ equity and also cash.

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Classifications of Cash Flows

A. Inflows of Cash. Increases in stockholders’ equity because of revenues, adjusted for changes in current assets and current liabilities that are related to the operating cycle, as well as changes in certain noncurrent assets and liabilities.

B. Outflows of Cash. Decreases in stockholders’ equity because of expenses, adjusted for changes in current assets and current liabilities that are related to the operating cycle, as well as changes in certain noncurrent assets and liabilities.

Operating Cash Flows

ContinuedContinuedContinuedContinued

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Classifications of Cash Flows

A. Inflows of Cash. Decreases in noncurrent assets and certain current assets.

B. Outflows of Cash. Increases in noncurrent assets and certain current assets.

A. Inflows of Cash. Increases in noncurrent liabilities, stockholders’ equity, and certain current liabilities.

B. Outflows of Cash. Decreases in noncurrent liabilities, stockholders’ equity, and certain current liabilities.

Investing Cash Flows

Financing Cash Flows

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Noncash Simultaneous Investing/Financing Transactions

Acquisitions of assets by issuing equity securities Acquisitions of assets by assuming liabilities such as

capital lease obligations Exchanges of debt securities for equity securities such

as the conversion of bonds to common stock Exchanges of assets for assets Exchanges of liabilities for liabilities Exchanges of equity securities such as the conversion of

preferred stock to common stock

Examples of changes in assets, liabilities, and stockholders’ equity that may be the result of investing and financing activities not affecting cash include:

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Net Cash Flow From Operating Activities

GAAP allows two ways for a company to calculate and

report its net cash flow from operating activities on its statement of cash flows.

GAAP allows two ways for a company to calculate and

report its net cash flow from operating activities on its statement of cash flows.

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Net Cash Flow From Operating Activities

Even though GAAP recommends the direct

method, most companies (99%) use the indirect

method.

Even though GAAP recommends the direct

method, most companies (99%) use the indirect

method.

The first is called the direct method and the second is the indirect

method.

The first is called the direct method and the second is the indirect

method.

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Direct Method

Under the direct method, a company deducts its operating

cash outflows from its operating cash inflows to determine its net

cash flow from operating activities.

Under the direct method, a company deducts its operating

cash outflows from its operating cash inflows to determine its net

cash flow from operating activities.

Inflows• Collections from

customers• Collections of interest

and dividends• Other operating

receipts

Outflows• Payments to suppliers• Payments to employees• Other operating

payments• Payments for interest• Payments for income

taxes

Operating Activities—Direct Method

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Steps in Visual Inspection Method

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Step 1: Prepare the column headings on a worksheet. Then enter the account title Cash on the first line of the account titles column and list the beginning balance, ending balance, and the change in cash in the respective columns.

Step 2: Enter the titles of all the remaining accounts from the balance sheets on the worksheet and list each beginning and ending account balance, and the change in the account balance directly below the cash information.

Steps in the Worksheet (Spreadsheet) Method

Steps 1–3: Setting up the worksheetSteps 1–3: Setting up the worksheet


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Step 3: Directly below these accounts, add the following headings:

A. Net Cash Flow From Operating Activities

B. Cash Flows From Investing Activities

C. Cash Flows From Financing Activities

D. Investing and Financing Activities NotAffecting Cash

Leave sufficient room below each heading so that each type of cash flow may be listed.


Steps 1–3: Setting up the worksheetSteps 1–3: Setting up the worksheet


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Account for all the changes in the noncash accounts. Reconstruct the journal entries that caused the changes in the noncash accounts directly on the worksheet. Use these general rules:

A. Start with net income.

B. Account for the changes in the current assets (except cash) and current liability accounts.

C. Account for the changes in the noncurrent accounts.


Step 4: Completion of the worksheetStep 4: Completion of the worksheet


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Make a final worksheet entry to record the net change in cash. The difference between the total cash inflows and outflows must be equal to the change in the Cash account.

Prepare the statement of cash flows and accompanying schedule from the information developed on the worksheet.


Step 5: Record the net change in cashStep 5: Record the net change in cash

Step 6: Prepare the final worksheet entryStep 6: Prepare the final worksheet entry

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Jones Company: Condensed Financial

Information

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Changes in LandChanges in Land

First, let’s reconstruct the original entry.

First, let’s reconstruct the original entry.

During the year, the company sold

land for $3,900 that cost $2,200.

During the year, the company sold

land for $3,900 that cost $2,200.

Worksheet Entries for Investing and Financing Activities

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Cash Flow Worksheet for 2010 (Jones Company)

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During the year, an earthquake (extraordinary event) occurred that destroyed a building owned by the company with a cost of $10,000 and a book value of $5,200. The company received after-tax

cash proceeds of $3,100 from its insurance company.

During the year, an earthquake (extraordinary event) occurred that destroyed a building owned by the company with a cost of $10,000 and a book value of $5,200. The company received after-tax

cash proceeds of $3,100 from its insurance company.


Changes in Buildings (and Extraordinary Loss)Changes in Buildings (and Extraordinary Loss)

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Cash Flows From Investing Activities: Proceeds From Building Destroyed by Earthquake 3,100Accumulated Depreciation: Building 4,800Net Cash Flow From Operating Activities: Extraordinary Loss 2,100

Buildings 10,000


Changes in Buildings (and Extraordinary Loss)Changes in Buildings (and Extraordinary Loss)

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On January 1, the company issued bonds payable with a face value of $10,000, receiving proceeds of $9,000. The company amortized $100 of the

discount during the year.

On January 1, the company issued bonds payable with a face value of $10,000, receiving proceeds of $9,000. The company amortized $100 of the

discount during the year.

Worksheet (Spreadsheet) Method

Changes in Bonds Payable (and Related Discount)

Changes in Bonds Payable (and Related Discount)

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Comprehensive Statement of Cash Flows

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IFRS require a company to include a cash flow statement as one of its basic financial statements.

Contrary to U.S. GAAP, IFRS do not require a company using the direct method to reconcile its net income to its operating cash flows.

IFRS require that the cash paid for any development costs that is capitalized as an intangible asset be reported as an investing cash outflow.

IFRS allow the reporting of dividends and interest paid as either an operating cash outflow or a financing cash outflow.

IFRS vs. U.S. GAAP

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IFRS allow the reporting of dividends and interest received as either an operating cash inflow or an investing cash inflow.

IFRS allow the reporting of bank overdrafts as a financing cash flow.

IFRS allow the reporting of payments of income taxes identified with financing or investing transactions as financing or investing cash outflows.

IFRS allow the reporting of cash flow per share. IFRS allow more freedom in netting cash receipts and

payments.

IFRS vs. U.S. GAAP

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Brandt Company sold equipment with a cost of $2,200 and accumulated depreciation of $700 for

$2,100.

Brandt Company sold equipment with a cost of $2,200 and accumulated depreciation of $700 for

$2,100.

Here is another situation that was not part of the chapter’s comprehensive problem.

Here is another situation that was not part of the chapter’s comprehensive problem.

Sale of Depreciable Asset

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Sale of Depreciable Asset

Cash Flows From Investing Activities: Proceeds From Sale of Equipment 2,100Accumulated Depreciation 700

Equipment 2,200Net Cash Flow From Operating Activities:

Gain on Sale of Equipment 600

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Retirement of Bonds

Assume Rosen Company paid $8,900 to retire bonds with a face value of $10,000 and a book value of $9,700.

Assume Rosen Company paid $8,900 to retire bonds with a face value of $10,000 and a book value of $9,700.

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Bonds Payable 10,000Discount on Bonds Payable 300Cash 8,900Gain on Retirement of Bonds 800

Retirement of Bonds

The cash paid of $8,900 is a cash payment for a financing activity.

The gain increased net income but there was no cash inflow from operating activities.

Therefore, the gain from net income is subtracted in the operating activities section.

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Interest Paid and Income Taxes Paid

GAAP requires that a company using the indirect method of reporting its

operating cash flows to also disclose its interest paid and income taxes paid.

GAAP requires that a company using the indirect method of reporting its

operating cash flows to also disclose its interest paid and income taxes paid.

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GAAP flexibility

GAAP permits flexibility in reporting a company’s net cash from operating activities under the indirect method. That is, the

company may show the reconciliation of net income to the net cash provided by (or used in) operating activities in a separate

schedule accompanying its statement of cash flows.

GAAP permits flexibility in reporting a company’s net cash from operating activities under the indirect method. That is, the

company may show the reconciliation of net income to the net cash provided by (or used in) operating activities in a separate

schedule accompanying its statement of cash flows.

Flexibility in Reporting

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Partial Cash Investing and Financing Activities

One method to disclose the effects of this transaction is to report the cash payment on its

statement of cash flows and the noncash element on the accompanying schedule of investing and

financing activities not affecting cash.

One method to disclose the effects of this transaction is to report the cash payment on its

statement of cash flows and the noncash element on the accompanying schedule of investing and

financing activities not affecting cash.

Small Amount of CashSmall Amount of Cash

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Partial Cash Investing and Financing Activities

When the amount of cash is large in such an exchange, it may be more appropriate to report the items in the statement of cash flows. Several alternative disclosure formats are acceptable.

When the amount of cash is large in such an exchange, it may be more appropriate to report the items in the statement of cash flows. Several alternative disclosure formats are acceptable.

Large Amount of CashLarge Amount of Cash

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On November 28, 2010, the Dougherty Company purchased 1,000 shares of Bear Company common stock for $40,000 as a temporary

investment in available-for-sale securities. On December 31, 2010, the fair value of the stock was

$42 per share.

On November 28, 2010, the Dougherty Company purchased 1,000 shares of Bear Company common stock for $40,000 as a temporary

investment in available-for-sale securities. On December 31, 2010, the fair value of the stock was

$42 per share.

1. Reconstruct the two entries related to this investment.

2. Make the worksheet entry in journal format.



Temporary and Long-Term Investments

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1. Temporary Investment in Available-for-Sale Securities 40,000

Cash 40,000

2. Temporary Investment in Available-for-Sale Securities 40,000

Cash Flows From Investing Activities: Payment for Purchase of Temporary Investments 40,000



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1. Allowance for Change in Value of Investment 2,000Unrealized Increase in Value of Available- for-Sale Securities 2,000

2. Allowance for Change in Value of Investment 2,000Unrealized Increase in Value of Available- for-Sale Securities 2,000


No change! The debit portion appears only in the upper part of the worksheet.

No change! The debit portion appears only in the upper part of the worksheet.

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On January 16, 2011, the Dougherty Company sold its investment in Bear Company stock for

$45,000.

On January 16, 2011, the Dougherty Company sold its investment in Bear Company stock for

$45,000.

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1. Cash 45,000Temporary Investment in Available-for- Sale Securities 40,000Gain on Sale of Temporary Investment 5,000


2. Cash Flows From Investing Activities: Proceeds From Sale of Temporary Investment 45,000

Temporary Investment in Available-for- Sale Securities 40,000Net Cash Flow From Operating Activities: Gain on Sale of Temporary Investment 5,000


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1. Unrealized Increase in Value of Available-for- Sale Securities 2,000

Allowance for Change in Value of Investment 2,000


No change! No change!

2. Unrealized Increase in Value of Available-for- Sale Securities 2,000

Allowance for Change in Value of Investment 2,000

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Financial Institutions

GAAP is different for banks, brokers and dealers in securities, and other similar companies that hold loans for resale on a short-term basis or carry securities in a “trading account.”

The FASB requires that the cash flows from the purchases or sales of these trading accounts be reported in the operating activities section of the statement of cash flows.

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Financial Institutions

Banks and other financial institutions are allowed to report the net cash flows for:1. Deposits and withdrawals with other financial

institutions

2. Time deposits accepted and repaid

3. Loans made to customers and principal collections of these loans

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Cash Dividends Declared

In some instances, a company will declare a cash dividend in the current year and pay the cash dividend in the next year. – In this case, the cash dividend is handled differently in preparing the

worksheet for the statement of cash flows.

When a company follows a policy of declaring a dividend in one year and paying the dividend in the next year, its Dividends Payable account balance will change during each year.

A comparison of the change in the account balance to the dividends reported on the retained earnings statement will determine the worksheet entry necessary to account for the cash dividends.

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Cash Flows for Compensatory Share Option Plans

If compensation expense for compensatory share option plans is reported for financial purposes but not for income tax purposes, the result is a deferred tax asset for the future deductible amount.

Therefore, on the corporation's statement of cash flows, under the indirect method the increase in compensation expense must be added back to net income and the increase in the deferred tax asset must be subtracted from net income to help determine the net cash flow from operating activities.

Inflows• Collections from

customers• Interest and dividends

collected• Other operating

receipts

Outflows• Payments to suppliers• Payments to employees• Other operating

payments• Payments of interest• Payments of income

taxes

Appendix: Operating Cash Flows

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Appendix: Major Adjustments to Convert Income

Statement Amounts to

Operating Cash Flows

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Appendix: Procedures for Statement Preparation

Normally, under the direct method, a company obtains the information for its statement of cash flows from the following working papers: Post-closing trial balance (or balance sheet)

from previous period Adjusted trial balance of current period

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Appendix: Visual Inspection Method

Make adjustments to the applicable revenues for the period to determine the amounts of collections from customers, interest and dividends collected, and other operating receipts.

Make adjustments to the applicable expenses for the period to determine the amounts of payments to suppliers, payments to employees, other operating payments, payments of interest, and payments of income taxes.

Under the visual inspection method, the steps to complete the statement of cash flows using the direct method for operation activities are similar to those for the indirect method, except that the information for the cash flows from operating activities section is computed as follows:

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Appendix: Steps in Worksheet Approach for Direct Method

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Chapter 22

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the statement of cash flows c hapter 22 copyright © 2010 south-western/cengage learning...

Documents

cash flow statement

outflows of cash

inflows of cash

inflow of cash

related cash receipts

cash flow information

positive future net

companys financing