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Conducted by: Mr. Koy Chumnith The Statement of Cash Flows Revisited 21 McGraw-Hill/Irwin 2011, Royal University of Law and Economics.

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Presentation on theme: "Conducted by: Mr. Koy Chumnith The Statement of Cash Flows Revisited 21 McGraw-Hill/Irwin 2011, Royal University of Law and Economics."— Presentation transcript:

1 Conducted by: Mr. Koy Chumnith The Statement of Cash Flows Revisited 21 McGraw-Hill/Irwin 2011, Royal University of Law and Economics

2 Investing ActivitiesOperating ActivitiesFinancing Activities Sale of operational assets Sale of investments Collections of loans Cash received from revenues Issuance of stock Issuance of bonds and notes CASH INFLOWS Business CASH OUTFLOWS Purchase of operational assets Purchase of investments Loans to others Cash paid for expenses Payment of dividends Repurchase of stock Repayment of debt

3 Role of the Statement of Cash Flows Helps users assess... a firms ability to generate cash. a firms ability to meet its obligations. the reasons for differences between income and associated cash flows. the effect of cash and noncash investing and financing activities on a firms financial position. Helps users assess... a firms ability to generate cash. a firms ability to meet its obligations. the reasons for differences between income and associated cash flows. the effect of cash and noncash investing and financing activities on a firms financial position.

4 Role of the Statement of Cash Flows Lists all cash inflows and all cash outflows by category: Operating, Investing, and Financing Explains the change in cash during the period Required by GAAP Cash is King! Especially during an economic downturn

5 Cash and Cash Equivalents Short-term, highly liquid investments. Readily converted into cash, with little or no risk of loss. Examples: money market funds Treasury bills Maturity date must not be longer than 3 months from date of purchase. Resources immediately available to pay obligations.

6 Operating Activities Investing Activities Financing Activities Reconciliation of the Net Increase or Decrease in Cash with the Change in the Balance of the Cash Account Noncash Investing and Financing Activities Primary Elements of the Statement of Cash Flows

7 Investing Activities Reports the cash effects of the acquisition and disposition of assets (other than inventory and cash equivalents). Financing Activities Reports the cash effects of the sale or repurchase of shares, the issuance or repayment of debt securities, and the payment of cash dividends. Primary Elements of the Statement of Cash Flows Operating Activities Reports the cash effects of the elements of net income.

8 Cash Flows from Operating Activities + Inflows from: customers. interest and dividends. _ Outflows to: suppliers of goods. salaries and wages. interest on debt. income taxes.

9 Direct Method or Indirect Method of Reporting Cash Flows from Operating Activities Reports the cash effects of each operating activity Direct Method Starts with accrual net income and converts to cash basis Indirect Method Two Formats for Reporting Operating Activities Note that no matter which format is used, the same amount of net cash flows operating activities is generated.

10 Direct Method Under the direct method, the cash effect of each operating activity is reported directly in the statement.

11 Indirect Method By the indirect method, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a cash basis.

12 Cash Flows from Investing Activities + Inflows from: Sale of long-term assets used in the business. Sale of investment securities (stocks and bonds). Collection of nontrade receivables. _ Outflows to: Purchase of long-term assets used in the business. Purchase of investment securities (stocks and bonds). Create nontrade receivables.

13 Cash Flows from Financing Activities Inflows from: Sale of shares to owners. Borrowing from creditors through notes, loans, mortgages, and bonds. Cash Flows from Financing Activities + _ Outflows to: Owners in the form of dividends or other distributions. Owners for the reacquisition of shares previously sold. Creditors as repayment of the principal amounts of debt.

14 Reconciliation with Change in Cash Balance The net amount of cash inflows and outflows reconciles the change in the companys beginning and ending cash balances. For example, assume that UBCs net increase in cash is $9 million and the Cash beginning balance is $20 million. The cash reconciliation would be as follows:

15

16 Noncash Investing and Financing Activities Significant investing and financing transactions not involving cash also are reported (usually in a disclosure note). 1.Acquiring an asset by incurring a debt payable to the seller. 2.Acquiring an asset by entering into a capital lease. 3.Converting debt into common stock or other equity securities. 4.Exchanging noncash assets or liabilities for other noncash assets or liabilities.

17 U.S. GAAP and IFRS The FASB and IASB are working together on a project, Financial Statement Presentation, to establish a common standard for presenting information in the financial statements.

18 U.S. GAAP and IFRS Based on the joint FASB and IASB Financial Statement Presentation project, the statement of cash flows is slated to change in several ways. Operating and Investing cash flows will be categorized as Business activities and some cash flows may switch categories. The statement will have three additional groupings: income taxes, discontinued operations, and equity (if needed). Direct method will be required. Eliminate the concept of cash equivalents in favor of cash only.

19 Preparation of the Statement of Cash Flows A spreadsheet can be used to ensure that no reportable activities are inadvertently overlooked. Reconstructing the events and transactions that occurred during the period helps identify the operating, investing and financing activities to be reported. Lets see how to use a spreadsheet to prepare a Statement of Cash Flows on the next few slides.

20 We begin by entering the beginning and ending balances for each account on the comparative balance sheet and income statement. The changes columns will be used later to explain the increase or decrease in each account balance

21 The beginning balances for income statement accounts are always zero

22 Next we allocate space on the spreadsheet for the statement of cash flows. Spreadsheet entries duplicate the actual journal entries used to record the transactions as they occurred during the year. They are only entered on the spreadsheet and are not recorded in the accounting records

23 Lets start by analyzing Sales Revenue and its related account Accounts Receivable by looking at the relationship in a T-account format

24 We can see from this analysis that cash received from customers must have been $98 million. Lets see how to post this entry to the spreadsheet

25 First, $2 million is debited to Accounts Receivable to account for the total change in the account. Then, $100 million is credited to Sales Revenue to account for the total change in the account

26 The final part of this entry is a $98 million entry on the Statement of Cash Flows under Cash Inflows from Customers

27 Note that in the textbook, entry number 12 illustrates the analysis of the Short-term Investment account. The $12 million increase in the Short-term Investments account is due to the purchase of short-term investments during the year

28 The final part of this entry is a $12 million entry on the Statement of Cash Flows under Investing Activities

29 In entry number 14, we find that a note payable was issued as payment for a building. Investing in a new building is a significant investing activity and financing the acquisition with long-term debt is a significant financing activity. x x

30 x x After entering all the transactions, this is what the balance sheet portion of the spreadsheet looks like

31 After entering all the transactions, this is what the income statement portion of the spreadsheet looks like

32 After entering all the transactions, this is what the statement of cash flows portion of the spreadsheet looks like

33 Here is the Statement of Cash Flows prepared using the direct method

34 U.S. GAAP vs. IFRS Operating Activities –Dividends Received –Interest Received –Interest Paid Investing Activities Financing Activities –Dividends Paid Operating Activities Investing Activities –Dividends Received –Interest Received Financing Activities –Dividends Paid –Interest Paid Typical Classification of Interest and Dividends Consistent with U.S. GAAP, cash flows are classified as operating, investing, or financing.

35 Preparing an SCF: The Indirect Method Getting There through the Back Door The indirect method derives the net cash increases or decreases from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a cash basis.

36 Components of Net Income that Do Not Increase or Decrease Cash Depreciation Expense Loss on Sale of Equipment Adding these items back to net income restores net income to what it would have been had depreciation and the loss not been subtracted at all. Subtracting the gain reverses the effect of the gain having been added to net income. Gain on Sale of Land

37 Components of Net Income that Do Increase or Decrease Cash Note: Cash and cash equivalents, short-term investments in securities available for sale, dividends payable, and short-term payables to financial institutions are excluded from this category. For components of net income that increase or decrease cash, but by an amount different from that reported on the income statement, net income is adjusted for changes in the balances of related balance sheet accounts to convert the effects of those items to a cash basis.

38 Comparison with the Direct Method

39 Appendix 21A: Spreadsheet for the Indirect Method A spreadsheet is equally useful in preparing a statement of cash flows whether we use the direct or the indirect method of determining cash flows from operating activities.

40 Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flows The T-Account method serves the same purpose as a spreadsheet in assisting in the preparation of a statement of Cash Flows.

41 Appendix 21B: The T-Account Method of Preparing the Statement of Cash Flows 1.Draw a T-account for each income statement and balance sheet account. 2.The T-account for cash should be drawn considerably larger. 3.Enter each accounts net change on the appropriate side (debit or credit) of the uppermost portion of each T- account. 4.Reconstruct the transactions that caused changes in each account balance during the year and record the entries for those transactions directly in the T-accounts. 5.After all account balances have been explained by T- account entries, prepare the statement of cash flows from the cash T-account, being careful also to report noncash investing and financing activities.

42 End of Chapter 21


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