University of California, Santa Barbara

University of California, Santa Barbara
Prepared by Coby Harmon University of California, Santa Barbara Westmont College Copyright ©2015 Pearson Education Inc. All rights reserved.

IDENTIFY THE PURPOSES OF THE STATEMENT OF CASH FLOWS Statement of cash flows Reports cash flows Cash receipts Cash payments Covers a span of time (month, quarter, year) Includes cash equivalents LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

IDENTIFY THE PURPOSES OF THE STATEMENT OF CASH FLOWS
Serves these purposes: Predicts future cash flows Evaluates management decisions Determines ability to pay dividends and interest Shows relationship of net income to cash flows LO 1 Copyright ©2015 Pearson Education Inc. All rights reserved.

DISTINGUISH AMONG OPERATING, INVESTING, AND FINANCING ACTIVITIES Three types of business activities: Operating Create revenue, expenses, gains and losses—net income Investing Cash flows related to long-term assets Financing Cash flows related to long-term liabilities and owners’ equity LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

DISTINGUISH AMONG OPERATING, INVESTING, AND FINANCING ACTIVITIES Exhibit 12-2 | How Operating, Investing, and Financing Activities Affect the Balance Sheet LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

Two Formats for Operating Activities Indirect Reconciles from net income to net cash provided by operating activities Direct Reports all cash receipts and cash payments from operating activities LO 2 Copyright ©2015 Pearson Education Inc. All rights reserved.

PREPARE A STATEMENT OF CASH FLOWS
Exhibit 12-3 | Part 1 PREPARE A STATEMENT OF CASH FLOWS BY THE INDIRECT METHOD LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

INDIRECT METHOD Operating Activities Positive Items Negative Items Net income Depreciation and amortization Loss on sale of long-term assets Decreases in current assets other than cash Increase in current liabilities Net loss Gain on sale of long-term assets Increase in current assets other than cash Decrease in current liabilities LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

INDIRECT METHOD Investing Activities Positive Items Negative Items Sale of plant assets Sale of investments that are not cash equivalents Collections of loans receivable Acquisition of plant assets Purchase of investments that are not cash equivalents Making loans to others LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

INDIRECT METHOD Financing Activities Positive Items Negative Items Issuing stock Selling treasury stock Borrowing money Payment of dividends Purchase of treasury stock Payment of principal amounts of debts LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

PREPARE A STATEMENT OF CASH FLOWS BY THE INDIRECT METHOD To illustrate the statement of cash flows, we use The Roadster Factory, Inc. (TRF), a dealer in auto parts for sports cars. Using the comparative balance sheets for 2014 and and the income statement for 2014, prepare the statement of cash flows using the indirect method. LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Flows from Operating Activities Transactions that make up net income From the income statement Net income Depreciation, depletion and amortization expense Gains and losses on sales of long-term asset From the comparative balance sheets Increase or decrease in each current asset (other than cash) Increase or decrease in each current liability LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Flows Template: Operating Cash Flows From Operating Activities Net income Adjustments to reconcile net income to net cash provided by operating activities: + Depreciation/depletion/amortization expense Loss on sale of long-term assets - Gain on sale of long-term assets Increases in current assets other than cash Decreases in current assets other than cash Increases in current liabilities Decreases in current liabilities = Net cash provided by (used for) operating activities LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

From the Income Statement
The Roadster Factory, Inc. (TRF) Partial Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2014 Cash Flows From Operating Activities Net income $50,000 Adjustments to reconcile net income to net cash provided by operating activities: Net cash provided by (used for) operating activities From the Income Statement LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Depreciation, Depletion, and Amortization Added back to net income to convert net income to cash flow No effect on cash, decreases net income Add-back cancels the deduction on the income statement The Roadster Factory, Inc. (TRF) reports Depreciation Expense of $18,000 on their 2014 income statement (Exhibit 12-5) LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

The Roadster Factory, Inc. (TRF) Partial Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2014 Cash Flows From Operating Activities Net income $50,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 18,000 Net cash provided by (used for) operating activities From the Income Statement LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Gains and Losses on Sale of Long-Term Assets Gain or loss is an adjustment to net income The Roadster Factory sold equipment for $62,000. The book value was $54,000, so there was a gain of $8,000. Net income also includes the gain Must subtract gain from operating activities as it is included in $62,000 reported in investing section ($54,000 + $8,000 = $62,000) LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

The Roadster Factory, Inc. (TRF) Partial Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2014 Cash Flows From Operating Activities Net income $50,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 18,000 Gain on sale of plant assets (8,000) Net cash provided by (used for) operating activities From the Income Statement LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Changes in Current Assets and Current Liabilities, Excluding Cash An increase in a noncash current asset decreases cash Accounts receivable increased $15,000 Sales revenue includes $15,000 not collected in cash Subtract from net income in operating section Prepaid expenses increased by $1,000, cash decreases Paid cash of $1,000 not deducted from net income LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

The Roadster Factory, Inc. (TRF)
Partial Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2014 Cash Flows From Operating Activities Net income $50,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 18,000 Gain on sale of plant assets (8,000) Increase in accounts receivable (15,000) Increase in prepaid expense (1,000) Net cash provided by (used for) operating activities LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Changes in Current Assets and Current Liabilities, Excluding Cash An decrease in a noncash current asset increases cash Inventory decreased $3,000 Decrease causes increase in Cost of Goods Sold, decrease in net income, but no corresponding decrease in cash Add to net income in operating section LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Partial Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2014 Cash Flows From Operating Activities Net income $50,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 18,000 Gain on sale of plant assets (8,000) Increase in accounts receivable (15,000) Increase in prepaid expense (1,000) Decrease in inventory 3,000 Net cash provided by (used for) operating activities LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Changes in Current Assets and Current Liabilities, Excluding Cash An increase in a current liability increases cash Accounts payable increased $34,000 Cash was not spent to pay this debt Cash payments are therefore less than expenses, and TRF has more cash on hand Increases in current liabilities increase cash Add to net income in operating section LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Partial Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2014 Cash Flows From Operating Activities Net income $50,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 18,000 Gain on sale of plant assets (8,000) Increase in accounts receivable (15,000) Increase in prepaid expense (1,000) Decrease in inventory 3,000 Increase in accounts payable 34,000 Net cash provided by (used for) operating activities LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Changes in Current Assets and Current Liabilities, Excluding Cash An decrease in a current liability decreases cash Salary and wages payable decreased $2,000 and Accrued liabilities decreased by $2,000 Payment of a current liability decreases cash but does not affect net income Subtract from net income in operating section LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Partial Statement of Cash Flows (Indirect Method) For the Year Ended December 31, 2014 Cash Flows From Operating Activities Net income $50,000 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 18,000 Gain on sale of plant assets (8,000) Increase in accounts receivable (15,000) Increase in prepaid expense (1,000) Decrease in inventory 3,000 Increase in accounts payable 34,000 Decrease in salary and wages payable (2,000) Decrease in accrued liabilities Net cash provided by operating activities $77,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Flows from Investing Activities Transactions that affect long-term assets Plant Assets, Investments, and Notes Receivable Increases in these accounts represent purchase Decreases to cash Decreases to these accounts represent sales Increases to cash LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Flows Template: Investing Cash Flows From Investing Activities + Sale of long-term assets - Purchases of long-term assets Collections of note receivable Loans to others = Net cash provided by (used for) investing activities LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Purchases and Sales of Plant Assets
For computing cash flows, it is helpful to combine all the plant assets into a single summary account Plant Assets, Net Beginning 219,000 18,000 Depreciation expense Acquisitions 196,000 54,000 Book value of assets sold Ending balance 343,000 Calculating the proceeds from the sale of plant assets Book value Gain – loss = Proceeds $54,000 + $8,000 – $0 = $62,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Purchases and Sales of Investments and Loans Investments Beginning 100,000 Purchases 50,000 10,000 Book value invest. sold Ending balance 140,000 Notes Receivable Beginning 0 New loans made 21,000 0 Collections Ending balance 21,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Flows from Financing Activities Transactions affecting liabilities and stockholders’ equity Notes Payable, Bonds Payable, Long-Term Debt, Common Stock, Paid-in Capital in Excess of Par, and Retained Earnings Most of the data comes from the balance sheet Increases are offset by increases in cash Decreases are offset by decreases in cash LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Flows Template: Financing Cash Flows From Financing Activities + Issuance of stock - Purchases of treasury stock Borrowing Payment of notes and bonds payable Payment of dividends = Net cash provided by (used for) financing activities LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Issuance and Payments of Long-Term Debt Long-Term Debt 77,000 Beginning balance Payments 11,000 94,000 Issuance of new debt 160,000 Ending balance If either new issuances or payments are known, the other amount can be computed. LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Issuance of Stock and Purchases of Treasury Stock Common Stock 158,000 Beginning balance 4,000 Issuance of new stock 162,000 Ending balance Treasury Stock Beginning balance 16,000 Purchase treasury stock 3,000 Ending balance 19,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Dividend Declarations and Payments Retained Earnings 86,000 Beginning balance Dividend declarations and payments 17,000 50,000 Net income 119,000 Ending balance LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Classify each of the following as an operating activity, an investing activity, or a financing activity as reported on the statement of cash flows prepared by the indirect method. a. Issuance of stock g. Paying bonds payable b. Borrowing long-term h. Interest expense c. Sales revenue i. Sale of equipment d. Payment of dividends j. Cost of goods sold e. Purchase of land with cash k. Purchase of another company with cash f. Purchase of treasury stock l. Making a loan Answers Financing Operating Investing Financing Operating Investing LO 3 12-42 Copyright ©2015 Pearson Education Inc. All rights reserved.

Noncash Investing and Financing Activities Exhibit illustrates noncash investing and financing activities (all amounts are assumed) Thousands Noncash investing and financing activities: Acquisition of building by issuing common stock $ 300 Acquisition of land by issuing note payable 70 Payment of long-term debt by issuing common stock 100 Total noncash investing and financing activities $ 470 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Income statement of Mueller Travel Products, Inc., for the year ended December 21, 2014: Illustration Income Statement Revenues: Service revenue $237,000 Dividend income 8,700 $245,700 Expenses: Cost of goods sold 100,000 Salary expense 59,000 Depreciation expense 28,000 Advertising expense 2,900 Interest expense 2,100 Income tax expense 14,000 206,000 Net income $39,700 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Additional data: Acquisition of plant assets was $130,000. Of this amount, $75,000 was paid in cash and $55,000 by signing a note payable. Proceeds from sale of land totaled $25,000. Proceeds from issuance of common stock totaled $50,000. Payment of long-term note payable was $16,000. Payment of dividends was $11,000. LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Illustration Balance sheet data of Mueller Travel Products, Inc., follow: December 31, 2014 2013 Change Current assets: Cash $125,000 $50,800 $74,200 Accounts receivable 41,000 57,000 (16,000) Inventory 94,000 73,000 21,000 Prepaid expenses 9,200 8,700 500 Current liabilities: Accounts payable 32,000 18,000 14,000 Accrued liabilities 82,000 25,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Mueller reported net income of $39,700. Cash Flows from Operating Activities Net income $ 39,700 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 28,000 Decrease in accounts receivable 16,000 Increase in inventory (21,000) Increase in prepaid expense (500) Increase in accounts payable 14,000 Increase in accrued liabilities 25,000 Net cash provided by operating activities $101,200 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Mueller reported depreciation expense of $28,000. Cash Flows from Operating Activities Net income $ 39,700 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 28,000 Decrease in accounts receivable 16,000 Increase in inventory (21,000) Increase in prepaid expense (500) Increase in accounts payable 14,000 Increase in accrued liabilities 25,000 Net cash provided by operating activities $101,200 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Mueller reports the change in all current assets and current liabilities, other than cash, as follows: Cash Flows from Operating Activities Net income $ 39,700 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense 28,000 Decrease in accounts receivable 16,000 Increase in inventory (21,000) Increase in prepaid expense (500) Increase in accounts payable 14,000 Increase in accrued liabilities 25,000 Net cash provided by operating activities $101,200 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Proceeds from sale of land totaled $25,000. Cash Flows from Investing Activities Sale of land $ 25,000 Purchases of plant assets (75,000) Net cash used for investing activities ($50,000) Cash Flows from Financing Activities Issuance of common stock 50,000 Payment of note payable (16,000) Payment of dividends (11,000) Net cash provided by financing activities $23,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Acquisition of plant assets was $130,000. Of this amount, $75,000 was paid in cash and $55,000 by signing a note payable. Cash Flows from Investing Activities Sale of land $ 25,000 Purchases of plant assets (75,000) Net cash used for investing activities ($50,000) Cash Flows from Financing Activities Issuance of common stock 50,000 Payment of note payable (16,000) Payment of dividends (11,000) Net cash provided by financing activities $23,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Proceeds from issuance of common stock totaled $50,000. Cash Flows from Investing Activities Sale of land $ 25,000 Purchases of plant assets (75,000) Net cash used for investing activities ($50,000) Cash Flows from Financing Activities Issuance of common stock 50,000 Payment of note payable (16,000) Payment of dividends (11,000) Net cash provided by financing activities $23,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Payment of long-term note payable was $16,000. Cash Flows from Investing Activities Sale of land $ 25,000 Purchases of plant assets (75,000) Net cash used for investing activities ($50,000) Cash Flows from Financing Activities Issuance of common stock 50,000 Payment of note payable (16,000) Payment of dividends (11,000) Net cash provided by financing activities $23,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Payment of dividends was $11,000. Cash Flows from Investing Activities Sale of land $ 25,000 Purchases of plant assets (75,000) Net cash used for investing activities ($50,000) Cash Flows from Financing Activities Issuance of common stock 50,000 Payment of note payable (16,000) Payment of dividends (11,000) Net cash provided by financing activities $23,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

Summary totals for the Statement of Cash Flows Net cash provided by operating activities $101,200 Net cash used for investing activities (50,000) Net cash provided by financing activities 23,000 Net increase in cash 74,200 Cash balance, December 31, 2013 50,800 Cash balance, December 31, 2014 $125,000 LO 3 Copyright ©2015 Pearson Education Inc. All rights reserved.

PREPARE A STATEMENT OF CASH FLOWS BY THE DIRECT METHOD FASB and IASB prefer the direct method of reporting operating cash flows Provides clearer information about sources and uses of cash Used by a small percentage of companies Requires more computations than indirect method Investing and financing cash flows are unaffected by the method used LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

DIRECT METHOD Operating Activities Positive Items Negative Items
Collections from customers Receipts of interest and dividends on investments Other operating receipts Payments to suppliers Payments to employees Payments of interest and income taxes Other operating payments Investing and financing cash flows are the same as the indirect method LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Direct Method Template: Operating Cash Flows From Operating Activities + Collections from customers Interest received - Payments to suppliers Payments to employees Payments for income tax Payments for interest = Net cash provided by (used for) operating activities LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Using the direct method, classify each of the following as an operating activity, an investing activity, or a financing activity. a. Net income b. Payment of dividends c. Borrowing long-term d. Payment of cash to suppliers e. Making a loan f. Sale of treasury stock g. Depreciation expense h. Purchase of equipment with cash a. Not reported Financing Operating Investing Not reported LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Using the direct method, classify each of the following as an operating activity, an investing activity, or a financing activity. Issuance of stock Purchase of another company with cash Payment of a long-term note payable Payment of income taxes Collections from customers Accrual of interest revenue Expiration of prepaid expense Receipt of cash dividends Financing Investing Operating Not reported LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Cash Collections from Customers Accounts Receivable Beginning balance 81,000 Sales 303,000 288,000 Collections Ending balance 96,000 $303,000 (Sales) - $15,000 (↑ A/R) = $288,000 LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Payments for Inventory
$150,000 (COGS) - $3,000 (↓ Inventory) - $34,000 (↑ A/P) = $113,000 Inventory Beginning balance 38,000 Purchases 147,000 150,000 Cost of goods sold Ending balance 35,000 Accounts Payable 57,000 Beginning balance Payments 113,000 147,000 Purchases 91,000 Ending balance LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Other Operating Expenses
Payments for Operating Expenses $17,000 (Expense) + $1,000 (↑ Prepaids) + $2,000 (↓Liabilities) = $20,000 Prepaid Expenses Other Operating Expenses Beg. balance 7,000 Accrual 1,000 Payments 8,000 7,000 Expired costs Expired costs 7,000 Payments 9,000 End. balance 8,000 Accrued Liabilities End. balance 17,000 3,000 Beg. balance Payments 3,000 1, Accrual 1,000 End. balance LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Salary and Wages Payable
Payments to Employees Salary and Wages Payable 6,000 Beginning balance Payments 58,000 56,000 Expense 4,000 Ending balance $56,000 (Expense) + $2,000 (↓Payable) = $58,000 Process is the same for determining cash payments for interest and income taxes LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

Measuring Cash Adequacy: Free Cash Flow
Net cash provided by operating activities Cash payments earmarked for investment in plant assets - = Amount of cash available from operations after paying for planned investments in plant assets LO 4 Copyright ©2015 Pearson Education Inc. All rights reserved.

This work is protected by United States copyright law and is provided solely for the use of instructors in teaching their courses and assessing student learning. Dissemination or sale of any part of this work (including on the World Wide Web) will destroy the integrity of the work and is not permitted. The work and materials from it should never be made available to students except by instructors using the accompanying text in their classes. All recipients of this work are expected to abide by these restrictions and to honor the intended pedagogical purposes and the needs of other instructors who rely on these materials. Copyright ©2015 Pearson Education Inc. All rights reserved.

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