2. BUS780 Chapter 4 Statement of Cash Flows

3. 2 Objectives of this Chapter I. Identify business activities which can generate or use cash and differentiate between income flows and cash flows from operating activities.

4. Statement of Cash Flows3 Objectives of this Chapter (contd.) II. Introduce the content and the usefulness of the statement of cash flows. III. Learn how to prepare the statement of cash flows.

5. Statement of Cash Flows4 I. Activities which can either generate cash or use cash for a business entity A. Operating activities. B. Investing activities. C. Financing activities.

6. Statement of Cash Flows5 I. Activities which can either generate cash or use cash for a business entity Operating activities: n Cash Inflows: 1. Collections from customers including cash received from sales (or services) and collections of A/R. 2. Cash receipts of interests or dividends. 3. Collections of other operating receipts (i.e., unearned revenue, rent revenue).

7. Statement of Cash Flows6 Cash Flows from Operating Activities (contd.) n Cash Outflows: 1. Payments to suppliers. 2. Payments to employees. 3. Payments for interest expense. 4. Payments for income taxes. 5. Payments for other expenses(i.e., Prepaid expenses; rent expenses).

8. Statement of Cash Flows7 Differentiate between income flows and cash flows from operating activities. n All of these operating activities are also reported in the income statement (I/S). n I/S is prepared on an accrual basis. n Statement of Cash Flows is prepared on a cash basis. Therefore, net income ǂ cash flows in most cases.

9. Statement of Cash Flows8 Operating Activities (contd.) n Two approaches can be used to reconcile net income to net cash flows of operating activities: 1. Indirect Method ==> Lump-Sum Adjustment 2. Direct Method ==> Individual Account Adjustment

10. Statement of Cash Flows9 Reconciliation: Indirect Method n Adjust net income for all differences between income flows (on an accrual basis) and cash flows (on a cash basis).

11. Statement of Cash Flows10 Reconciliation: Direct Method n Adjust each revenue account on I/S to cash collection and adjust each expense account to cash payment. n Subtract total cash payments from total cash collections to derive net cash flows of the operation activities.

12. Statement of Cash Flows11 Activities which can either generate cash or use cash for a business entity A. Operating activities. B. Investing activities. C. Financing activities.

13. Statement of Cash Flows12 Cash Flows from Investing Activities n Transactions involving acquiring (  Investing (Cash outflows)) and selling (  Disinvesting (Cash inflows)) : a. Property, Plant and Equipment. b. Investments (current and non- current). c. Notes Receivable (current and non- current).

14. Statement of Cash Flows13 Notes Receivable n Notes Receivable (current and non- current), including: u Lending money (N/R , cash outflow); u Collecting of loan (N/R , cash inflow); u Selling of N/R (N/R , discounting N/R, cash inflow)

15. Statement of Cash Flows14 Activities which can either generate cash or use cash for a business entity A. Operating activities. B. Investing activities. C. Financing activities.

16. Statement of Cash Flows15 Cash Flows from Financing Activities n Obtaining resources from owners and creditors (cash inflows) and repaying the amount borrowed (cash outflows). n Cash inflows: u Cash received from issuance of common stock. u Cash received from issuance of bonds. u Cash received from issuance of N/P (short-term or long term).

17. Statement of Cash Flows16 Cash Flows from Financing Activities (contd.) n Cash Outflows: u Retirement of bonds. u Retirement of stock. u Payments of N/P. u Payments of dividends.

18. Statement of Cash Flows17 II. The Content and the Usefulness of the Statement of Cash Flows n In order to show cash flows of a company, cash flows of all three activities occurred during the reporting period should be reported in one statement. n In addition, the following questions can be answered:

19. Statement of Cash Flows18 The Content and the Usefulness of the Statement of Cash Flows (contd.) 1. What is the relationship between net income and cash provided by operations? 2. Why did cash decreased when net income increased? 3. What expansion (investment) activities took place and how were they financed?

20. Statement of Cash Flows19 The Content and the Usefulness of the Statement of Cash Flows (contd.) 4. How much is the cash provided by operating activities? 5. What happened to the proceeds received from issuance of bonds or common stock?

21. Statement of Cash Flows20 SFAS No. 95 n SFAS No. 95, “Statement of Cash Flows,” requires companies present the statement of cash flows using a specific format.

22. Statement of Cash Flows21 SFAS No. 95 (contd.) n Following SFAS No. 95, the statement of cash flows should have three sections: 1. Cash flows from operating activities. 2. Cash flows from investing activities. 3. Cash flows from financing activities.

23. Statement of Cash Flows22 III. Procedures for Preparation of the Statement of Cash Flows 1. Operating Cash Flows (indirect method). 2. Investing Cash Flows. 3. Financing Cash Flows.

24. Statement of Cash Flows23 1. Operating Cash Flows (Indirect Method; Reconciliation Method) Net Income  Adjustments + Any increase in current Liabilities (except for N/P) + Any decrease in current assets (except for cash and N/R) - Any decrease in current liabilities (except for N/P) - Any increase in current assets (except for cash and N/R)

25. Statement of Cash Flows24 Adjustments to Convert Net Income to Net Cash Flow from Operating Activities + Depreciation expense, Bad Debt expense + Loss on disposal of assets or liabilities - Gain on disposal of assets or liabilities Net Income Adjustments

26. Statement of Cash Flows25 2. Investing Cash Flows Inflows: decrease in noncurrent assets (i.e., long-term investments, P.P.E.) and certain current assets (i.e., trading securities, N/R). Outflows: increases in noncurrent assets and certain current assets

27. Statement of Cash Flows26 3. Financing Cash Flows Inflows: increases in noncurrent liabilities (i.e., B/P, N/P), stockholders’ equity and certain current liability (i.e., N/P). Outflows: decreases in noncurrent liabilities, stockholders’ equity, certain current liability and dividend payment.

28. Statement of Cash Flows27 Adjustments: + Loss on Disposal of Assets or Liability n Example: Sale a piece of land with a cost of $9,000 for $7,000 Cash7,000 Loss on Sale of Land a 2,000 Land9,000 a. This transaction results in a cash increase of $7,000.

29. Statement of Cash Flows28 Data needed to prepare statement of cash flows 1. Comparative balance sheet statements. 2. The income statement. 3. The retained earnings statement. 4. Other supplemental information concerning the reasons for the changes in the B/S accounts (other than cash).

30. Statement of Cash Flows29 Example 1 Layton Company Balance Sheet (12/31/x2) a. Land was sold at cost for cash during the year. b. A building was purchased for cash during the year and no building or equipment was sold during the year.

31. Statement of Cash Flows30 Example 1 (contd.) Layton Company Balance Sheet (12/31/x2) a. Bonds were issued at the end of year.

32. Statement of Cash Flows31 Example 1 (contd.) Income Statement (for the year ended 12/31x2)

33. Statement of Cash Flows32 Example 1 (contd.) Layton Company Retained Earnings (20x2)

34. Statement of Cash Flows33 Layton Company Statement of Cash Flows For the Year Ended December 31, 20x2 Net cash flow from operating activities: Net Income$7,000 Adjustments to reconcile net income to net cash provided by operating activities: Add:Depreciation expense2,300 Increase in A/P1,500 Less:Increase in A/R(2,700) Net cash provided by operating activities$8,100

35. Statement of Cash Flows34 Layton Company Statement of Cash Flows (contd.) Cash flows from investing activities: Proceeds from sale of land$3,000 Payments for purchase of building(12,000) Net cash used by investing activities(9,000) Cash flows from financing activities: Proceeds from issuance of bonds7,000 Payments of dividends(3,500) Net cash provided by financing activities3,500

36. Statement of Cash Flows35 Layton Company Statement of Cash Flows (contd.) Net increase in cash$2,600 Cash, Jan 1, 19x2$4,000 Cash, Dec 31, 19x2$6,600

37. Statement of Cash Flows36 Example 2: Green Company Balance Sheet Accounts 1/1/x212/31/x2Difference Cash$3,500$5,500 A/R4,4003,600800  Inventory5,0006,6001,600  Land8,20012,2004,000 c  Building & Equip35,70048,70013,000 a,d  Acc. Depr.(6,000)(8,700) Total Assets$50,800$67,900

38. Statement of Cash Flows37 Green Company Balance Sheet (contd.) A/P$5,100$3,2001,900  Salary Payable1,4001,800400  B/P, 10%7,00015,0008,000 b  Common Stock, $10 par8,0009,0001,000  Paid-in Capital16,00019,0003,000  R/E13,30019,900 Total Liabilities & Equity$50,800$67,900

39. Statement of Cash Flows38 Income Statement For the Year Ended 12/31/20x2 Sales Revenue$80,000 CGS(48,600) Gross Profit$31,400 Operating Expenses: Deprecation Expense$3,400 Other Expenses15,900(19,300) $12,100 Other Revenues & Expenses Gains on Sale of Equipment$600 Interest Expense (700) (100) Income Before Income Tax$12,000 Income Tax Expense(3,600) Net Income$8,400. 38

40. Statement of Cash Flows39 Retained Earnings (20x2) Beginning balance of retained earnings$13,300 Add: Net Income 8,400 21,700 Less: Dividends (1,800) Ending balance of retained earning $19,900

41. Statement of Cash Flows40 Supplemental Information for 20x2 (a)Equipment was purchased for cash at a cost of $15,200. (b)Ten-year bonds payable with a face value of $8,000 were issued for $8,000 at the end of the year. (c) Land was acquired through the issuance of 100 shares of $10 par common stock when the stock was selling at a market price of $40 per share. (d)Equipment with a cost of $2,200 and a book value of $1,500 was sold for $2,100 cash.

42. Statement of Cash Flows41 GREEN Company Statement of Cash Flows For the Year Ended December 31, 20x2 Net cash flows from operating activities: Net Income$8,400 Adj. To reconcile net income to net cash provided by operating activities: Add:Depreciation Expense3,400 Decrease in A/R800 Increase in S/P400 Less:Increase in Inventory(1,600) Decrease in A/P(1,900) Gain on sale of Equipment(600) Net cash provided by operating activities$8,900

43. Statement of Cash Flows42 Cash flows from investing activities: Payments for purchase of equip.(15,200) Proceeds from sale of equipment2,100 Net cash used by investing activities(13,100) Cash flows from financing activities: Proceeds from issuance of bonds8,000 Payments of dividends(1,800) Net cash provided by financing activities6,200 Net increase in cash (see Schedule 1)$2,000 Cash, Jan 1, 19x2$3,500 Cash, Dec 31, 19x2$5,500 42 GREEN Company Statement of Cash Flows (contd.)

44. Statement of Cash Flows43 Schedule 1: Investing & financing activities not affecting cash flows: Investing activities: Acquisition of land by Issuance of common stock($4,000) Financing Activities: Issuance of common stock for land$4,000 43 GREEN Company Statement of Cash Flows (contd.)

45. Statement of Cash Flows44 1. Direct Exchange n Direct exchange: An example of a direct exchange is issuing bonds to acquire a building. This transaction should appear in the schedule of the cash flow statement as an investing activity (i.e., acquisition of building) and as a financing activity (i.e., issue bonds for building).

46. Statement of Cash Flows45 2. Partial Cash Investing and Financing Activities n Example: a cquiring land costing $10,000 by paying $1,000 down and signing a $9,000 notes payable.

47. Statement of Cash Flows46 2. Partial Cash Investing and Financing Activities (contd.) n Presentation on Cash Flow Statement for Partial Investing & Financing Activities: Cash Flows from Investing Activities: Purchase of land by issuance of note and cash($10,000) Less: issuance of note 9,000 Cash payment for purchase of land ($1,000)

48. Statement of Cash Flows47 V. Cash Flows from the Operating Activities Activities can be presented using: a. Indirect Method (as used in examples 1,2): N/I  Adjustments to reconcile net income to cash flows. b. Direct Method: The operating cash outflows are deducted from the operating cash inflows to determine the net cash provided by (or used in) operating activities.

49. Statement of Cash Flows48 Cash Flows from the Operating Activities (contd.) n SFAS No. 95 allows the use of both methods, but encourages the use of the direct method. n However, if the direct method is used, a reconcile of net income and cash using the indirect method must also be provided in the supplementary statement.

50. Statement of Cash Flows49 Using The Direct Method in Preparing The Operating Cash Flows Cash inflows from operating activities: 1. Collections from customers. 2. Interest & dividends collected. 3. Other operating receipts.

51. Statement of Cash Flows50 Using The Direct Method in Preparing The Operating Cash Flows (contd.) Cash outflows from operating activities: 1. Payments to suppliers. 2. Payments to employees. 3. Payments of interest. 4. Other operating payments. 5. Payments of income taxes.

52. Statement of Cash Flows51 Adjustments to Convert I/S Amount to Operating Cash Flows -- A Direct Approach I/SCash Flows from AmountsAdjustmentsOperating Activities Net Collections Sales +Dec. in A/R; or = from Revenue -Inc. in A/R Customers Cash +Dec. in Int. Rec.; Inflows -Inc. in Int. Rec. from Operating Interest InterestActivities

53. Statement of Cash Flows52 I/SCash Flows from Amounts Adjustments Operating Activities Net Dividend +Dec. in Dividend Rec. = Dividend Revenue -Inc. in Dividend Rec. Collected Cash +Inc. in Unearned Rev.; Inflows or from Other-Dec. in Unearned Rev. Operating Other Activities Revenue = Operating Receipts +Dec. (-Inc.) in Other Receivable Accounts * Ignore gain from sale of PPE because it does not have any cash inflows. 52 Adjustments to Convert I/S Amount to Operating Cash Flows (contd.)

54. Statement of Cash Flows53 I/S Cash Flows from Amounts Adjustments Operating Activities Net +Inc. in Inventory; Cost of or Payments Goods-Dec. in Inventory= to Sold+Dec. in A/P; or SuppliersCash -Inc. in A/P Outflows from Salary+Dec. in Sal. Payable; PaymentsOperating or= to Activities Expense-Inc. in Sal. Payable Employees 53 Adjustments to Convert I/S Amount to Operating Cash Flows (contd.)

55. Statement of Cash Flows54 I/SCash Flows from Amounts Adjustments Operating Activities Net +Dec. in Int. Payable Interest -Inc. in Int. Payable = Payments Expense of Interest Cash Outflows from +Inc. in Prepaids Operating -Dec. in Prepaids Activities Other = Operating Expense Payments +Dec. (-Inc.) in Other Payable Accounts 54 Adjustments to Convert I/S Amount to Operating Cash Flows (contd.)

56. Statement of Cash Flows55 I/SCash Flows from Amounts Adjustments Operating Activities Net +Dec. in I/T Payable; or Income-Inc. in I/T PayablePaymentsCash Tax= of IncomeOutflows ExpenseTax from Operating Activities Note: Ignore Bad Debt Expense, depreciation expense and loss from sale of PPE since those accounts do not have any cash outflows, 55 Adjustments to Convert I/S Amount to Operating Cash Flows (contd.)

57. Statement of Cash Flows56 Green Company Statement of Cash Flows (Using the direct method in preparing the operating activities section of a cash flow statement for Example 1) Cash flows from Operating Activities: Cash inflows: Collections from customers $29,100 1 Cash inflows from operating activities $29,100 1. 31,800 -2,700 = 29,100

58. Statement of Cash Flows57 Green Company Statement of Cash Flows (contd.) Cash outflows: Payments of interest (1,400) Other operating payments (16,600) 2 Payments of income tax (3,000) Cash outflows from operating activities(21,000) Net Cash inflows from Operating $8,100 Activities 18,100 - 1,500 = 16,600 * A reconciliation of net income and cash flows using indirect method must also be presented.

59. Statement of Cash Flows58 Green Company Statement of Cash Flows (Using the direct method in preparing the operating activities section of a cash flow statement of Example 2.) Cash flows from Operating Activities: Cash inflows: Collections from customers $80,800 1 Cash inflows from operating activities $80,800 1. 80,000 + 800 = 80,800.

60. Statement of Cash Flows59 Green Company Statement of Cash Flows (contd.) Cash outflows: Payments to suppliers$(52,100) 1 Payments of interest (700) Other operating payments (15,500) 2 Payments of income tax (3,600) Cash outflows from operating activities(71,900) Net Cash Flows from Operating $8,900 Activities 1. 48,600 + 1600 + 1900 = 52,100. 2. 15,900 - 400 = 15,500.

61. Statement of Cash Flows60 Green Company Statement of Cash Flows (contd.) Net cash inflow from operating activities $8,900 Cash flows from investing activities : : Cash flows from Financing Activities : : * A reconciliation of net income and cash flows using indirect method must also be presented.