1. Copyright © by Houghton Mifflin Company. All rights reserved.1 Principles of Accounting 2002e Belverd E. Needles, Jr. Marian Powers Susan Crosson - - - - - - - - - - - Multimedia Slides by: Harry Hooper Santa Fe Community College

2. Copyright © by Houghton Mifflin Company. All rights reserved.2 Chapter 17 The Statement of Cash Flows

3. Copyright © by Houghton Mifflin Company. All rights reserved.3 LEARNING OBJECTIVES cashcash equivalents. 1.Describe the statement of cash flows, and define cash and cash equivalents. 2.State the principal purposes and uses of the statement of cash flows. 3.Identify the principal components of the classifications of cash flows, and state the significance of noncash investing and financing transactions.

4. Copyright © by Houghton Mifflin Company. All rights reserved.4 4.Analyze the statement of cash flows. 5.Use the indirect method to determine cash flows from operating activities. 6.Determine cash flows from investing activities and financing activities. 7.Use the indirect method to prepare a statement of cash flows. 8.Prepare a work sheet for the statement of cash flows. 9.Use the direct method to determine cash flows from operating activities and prepare a statement of cash flows. LEARNING OBJECTIVES (continued) LEARNING OBJECTIVES (continued)

5. Copyright © by Houghton Mifflin Company. All rights reserved.5 OBJECTIVE 1 cash cash equivalents. Describe the statement of cash flows, and define cash and cash equivalents. Overview of the Statement of Cash Flows

6. Copyright © by Houghton Mifflin Company. All rights reserved.6 The Statement of Cash Flows u The statement of cash flows shows how a company’s operating, investing, and financing activities have affected cash during an accounting period. u It explains the net increase (or decrease) in cash during the accounting period.

7. Copyright © by Houghton Mifflin Company. All rights reserved.7 Cash and Cash Equivalents cash cash equivalents. u Cash includes cash and cash equivalents. u Cash equivalents are short-term, highly liquid investments, including money market accounts, commercial paper, and U.S. Treasury bills. u Cash equivalents are combined with the Cash account on the statement of cash flows. u Cash equivalents should not be confused with short-term investments or marketable securities.

8. Copyright © by Houghton Mifflin Company. All rights reserved.8Discussion Q. Q. Why are money market accounts, commercial paper (short-term notes), and U.S. Treasury bills considered cash equivalents? A. A. Because they are highly liquid, temporary (90 days or less) holding places for cash that is not currently needed to operate the business. They can be converted quickly into cash if needed.

9. Copyright © by Houghton Mifflin Company. All rights reserved.9 OBJECTIVE 2 State the principal purposes and uses of the statement of cash flows. Purposes of the Statement of Cash Flows

10. Copyright © by Houghton Mifflin Company. All rights reserved.10 Purposes of the Statement of Cash Flows u The statement of cash flows provides information about a company’s cash receipts and cash payments during an accounting period. u A secondary purpose of the statement is to provide information about a company’s operating, investing and financing activities during the accounting period.

11. Copyright © by Houghton Mifflin Company. All rights reserved.11 Internal Uses of the Statement of Cash Flows u Management uses the statement of cash flows to: 1.Assess liquidity. n Determine if short-term financing is necessary. 2.Determine dividend policy. n Decide whether to raise or lower dividends. 3.Evaluate the effects of decisions involving investments and financing. n Plan for investing and financing needs.

12. Copyright © by Houghton Mifflin Company. All rights reserved.12 External Uses of the Statement of Cash Flows u Investors and creditors use the statement of cash flows to assess a company’s ability to: 1.Manage cash flows. 2.Generate positive future cash flows. 3.Pay its liabilities. 4.Pay dividends and interest. 5.Anticipate its need for additional financing. u The statement reconciles net income with cash flows generated from operations. u The statement shows both cash and non-cash financing and investing activities.

13. Copyright © by Houghton Mifflin Company. All rights reserved.13Discussion Q. Q. What are the purposes of the statement of cash flows? A. A. The primary purpose of the statement of cash flows is to provide information about a company’s cash receipts and cash payments during an accounting period. A secondary purpose is to provide information about a company’s operating, investing, and financing activities during the period.

14. Copyright © by Houghton Mifflin Company. All rights reserved.14 OBJECTIVE 3 Identify the principal components of the classifications of cash flows, and state the significance of noncash investing and financing transactions. Classification of Cash Flows Classification of Cash Flows

15. Copyright © by Houghton Mifflin Company. All rights reserved.15 u The cash effects of transactions and other events that enter into the determination of net income. u Cash inflows include: 4 Cash receipts from customers for goods and services. 4 Interest and dividends received on loans and investments. 4 Sales of trading securities. Operating Activities

16. Copyright © by Houghton Mifflin Company. All rights reserved.16 u Cash outflows include: 4 Cash payments for wages, goods and services, expenses, interest, taxes and purchases of trading securities. u In effect, the income statement is changed from an accrual to a cash basis. Operating Activities

17. Copyright © by Houghton Mifflin Company. All rights reserved.17 u Acquiring and selling long-term assets, acquiring and selling marketable securities other than trading securities or cash equivalents, and making and collecting loans. u Cash inflows include: 4 Cash receipts from selling long-term assets and marketable securities. 4 Collecting loans. u Cash outflows. 4 Cash expended for purchases of long-term assets and marketable securities. 4 Cash loaned to borrowers. Investing Activities

18. Copyright © by Houghton Mifflin Company. All rights reserved.18 u Obtaining resources from or returning resources to owners and providing them with a return on their investment. u Obtaining resources from creditors and repaying the amounts borrowed or otherwise settling the obligations. Financing Activities

19. Copyright © by Houghton Mifflin Company. All rights reserved.19 u Cash inflows. 4 Proceeds from issues of stocks. 4 Proceeds from short-term and long-term borrowing. Financing Activities

20. Copyright © by Houghton Mifflin Company. All rights reserved.20 Financing Activities u Cash outflows. 4 Repayments of loans (excluding interest). 4 Payments to owners (including cash dividends). 4 Purchases of treasury stock. u Repayments of accounts payable or accrued liabilities are classified under Operating Activities.

21. Copyright © by Houghton Mifflin Company. All rights reserved.21 Classification of Cash Inflows and Cash Outflows

22. Copyright © by Houghton Mifflin Company. All rights reserved.22 Noncash Investing and Financing Transactions u These transactions involve only long-term assets, long-term liabilities, or stockholders’ equity in significant investing and financing activities, e.g. land for mortgage, assets for stock. u They are not reflected on the statement of cash flows because they do not involve either cash inflows or cash outflows. u The FASB has determined that they should be disclosed in a separate schedule as part of the statement of cash flows.

23. Copyright © by Houghton Mifflin Company. All rights reserved.23Discussion Q. Q. If noncash investing and financing transactions do not produce cash flows, why must they be disclosed? A. A. Because they involve activities that might be important to the reader. Also many noncash transactions involve a simultaneous inflow and outflow of cash and will require cash flows in the future.

24. Copyright © by Houghton Mifflin Company. All rights reserved.24 OBJECTIVE 4 Analyze the statement of cash flows. Analyzing the Statement of Cash Flows

25. Copyright © by Houghton Mifflin Company. All rights reserved.25 Cash-Generating Efficiency u Cash-generating efficiency (CGE) is the ability of a company to generate cash from its current or continuing operations. u There are three measures of CGE. 1. Cash Flow Yield 1. Cash Flow Yield = Net Cash Flows from _Operating Activities_ Net Income $605 $390 = 1.6 times =

26. Copyright © by Houghton Mifflin Company. All rights reserved.26 2. Cash Flows to Sales 2. Cash Flows to Sales = Net Cash Flows from Operating Activities Net Sales $605 $7,968 = 7.6% = 3. Cash Flows to Assets 3. Cash Flows to Assets = Net Cash Flows from Operating Activities Average Total Assets $605 ($6,233 + $5,161) / 2 = 10.6% =

27. Copyright © by Houghton Mifflin Company. All rights reserved.27 Free Cash Flow u Free cash flow (FCF) is the amount of cash that remains after deducting the funds the company must commit to continue operating at its planned level. positive, u If free cash flow is positive, the company has met all of its planned cash commitments and has cash available to reduce debt or expand. negative, u If free cash flow is negative, the company will have to sell investments, borrow money, or issue stock in the short term to continue at its planned levels. u FCF = Net Cash Flows from Operating Activities - Dividends - Purchases of Plant Assets + Sales of Plant Assets

28. Copyright © by Houghton Mifflin Company. All rights reserved.28Discussion Q. cash-generating efficiency Q. Define cash-generating efficiency and identify three ratios that measure cash- generating efficiency. A. A. Cash-generating efficiency is the ability of a company to generate cash from its current or continuing operations. Three ratios that measure cash-generating efficiency are cash flow yield, cash flows to sales, and cash flows to assets.

29. Copyright © by Houghton Mifflin Company. All rights reserved.29 OBJECTIVE 5 Use the indirect method to determine cash flows from operating activities. The Indirect Method of Preparing the Statement of Cash Flows

30. Copyright © by Houghton Mifflin Company. All rights reserved.30 The Indirect Method of Preparing the Statement of Cash Flows u There are four steps in preparing the statement of cash flows. 1.Determine cash flows from operating activities. 2.Determine cash flows from investing activities. 3.Determine cash flows from financing activities. 4.Use the information obtained in the first three steps to compile the statement of cash flows.

31. Copyright © by Houghton Mifflin Company. All rights reserved.31 Determining Cash Flows from Operating Activities u To arrive at cash flows from operations, the figures on the income statement must be converted from an accrual basis to a cash basis. u There are two methods of converting the income statement from an accrual basis to a cash basis: 1. The direct method. n Adjusts each item in the income statement from the accrual to the cash basis. 2. The indirect method. n Lists only those adjustments necessary to convert net income to cash flows from operations.

32. Copyright © by Houghton Mifflin Company. All rights reserved.32 Direct Method Cash Flows from Operating Activities Cash Receipts from Sales xxx Interest and Dividends Receivedxxx xxx Cash Payments for Purchasesxxx Operating Expensesxxx Interest Paymentsxxx Income Taxesxxxxxx Net Cash Flows from Operating Activities xxx

33. Copyright © by Houghton Mifflin Company. All rights reserved.33 Indirect Method Cash Flows from Operating Activities Net Incomexxx Adjustments to Reconcile Net Income to Net Cash Flows from Operating Activities (List of individual items) xxxxxx Net Cash Flows from Operating Activitiesxxx

34. Copyright © by Houghton Mifflin Company. All rights reserved.34 Indirect Method of Determining Net Cash Flows from Operating Activities

35. Copyright © by Houghton Mifflin Company. All rights reserved.35 u Depreciation, amortization, and depletion expense are allocations of expense and do not involve cash flows. u An adjustment is needed to increase net income by the amount of depreciation recorded to derive cash flows from operations.Depreciation

36. Copyright © by Houghton Mifflin Company. All rights reserved.36 Gains and Losses u Gains and losses do not affect cash flows from operating activities and need to be removed from this section. u Cash receipts from the disposal of long- lived assets are shown with investing activities, and therefore, gains and losses are removed from net income to prevent double counting.

37. Copyright © by Houghton Mifflin Company. All rights reserved.37 u Have opposite effect on cash flows compared to changes in current assets. u Increases have positive effects on cash flows. u Decreases have negative effects on cash flows. u EXAMPLE: Cash received from sales was calculated as $706,000 - $698,000 = $8,000 more than sales, which is added to net income. Accounts Receivable 706,000 Beg. Bal. 55,000 706,000 698,000 698,000 End. Bal. 47,000 Cash Receipts from Customers Sales to Customers Changes in Current Assets

38. Copyright © by Houghton Mifflin Company. All rights reserved.38 u Increases are added to income. u Decreases are deducted from net income. u EXAMPLE : Cash paid for purchases was $7,000 less than what appears on the income statement, which is added to net income. Changes in Current Liabilities 547,000 Beg. Bal. 43,000 554,000 554,000 End. Bal. 50,000 Accounts Payable Purchases Cash Paid to Suppliers

39. Copyright © by Houghton Mifflin Company. All rights reserved.39 Summary of Adjustments Items on Income Statement ADD TO ( OR DEDUCT FROM) Not Affecting Cash FlowsNET INCOME Depreciation ExpenseAdd Amortization ExpenseAdd Depletion ExpenseAdd LossesAdd GainsDeduct

40. Copyright © by Houghton Mifflin Company. All rights reserved.40 Summary of Adjustments ADD TO DEDUCT FROM NET INCOME NET INCOME NET INCOME NET INCOME Current Assets A/R (net)DecreaseIncrease InventoryDecreaseIncrease Prepaid ExpensesDecreaseIncrease

41. Copyright © by Houghton Mifflin Company. All rights reserved.41 Summary of Adjustments ADD TO DEDUCT FROM ADD TO DEDUCT FROM NET INCOME NET INCOME NET INCOME NET INCOME Current Liabilities A/P IncreaseDecrease Accrued Liabilities IncreaseDecrease Income Taxes Payable IncreaseDecrease

42. Copyright © by Houghton Mifflin Company. All rights reserved.42Discussion Q. Q. What are the essential differences between the direct method and the indirect method of determining cash flows from operations? A. A. Under the direct method, each item in the income statement is individually adjusted from an accrual basis to a cash basis. The indirect method does not require the individual adjustment of each item in the income statement, but lists only the adjustments necessary to convert net income to cash flows from operations.

43. Copyright © by Houghton Mifflin Company. All rights reserved.43 OBJECTIVE 6 Determine cash flows from investing activities. Determining Cash Flows from Investing Activities

44. Copyright © by Houghton Mifflin Company. All rights reserved.44 Cash Flows from Investing Activities u Each account that involves cash receipts and cash payments from investing activities is examined individually. u The objective is to explain the change in each account balance from one year to the next. u The focus is on long-term assets shown on the balance sheet and short-term investments from the current asset section of the balance sheet as well as investment gains and losses from the income statement.

45. Copyright © by Houghton Mifflin Company. All rights reserved.45 u The objective is to explain the corporation’s change in investments. u This is done by analyzing the increases and decreases in the Investments account to determine the effects on the Cash account. u Purchases (cash outflows) increase investments and sales (cash inflows) decrease investments.Investments

46. Copyright © by Houghton Mifflin Company. All rights reserved.46 Accounting for Cash Flows from Investing Activities Investments Sales 90,000 Beg. Bal. 127,000 Sales 90,000 Purchases 78,000 End. Bal. 115,000 Investments 78,000 Cash 78,000 Purchase of investments Cash 102,000 Investments 90,000 Gain on Sale of Investments 12,000 Sale of investments for a gain Decrease of $12,000

47. Copyright © by Houghton Mifflin Company. All rights reserved.47 u It is necessary to explain changes in both the asset and related accumulated depreciation accounts. increase decrease u Purchases (cash outflows) increase plant assets and sales (cash inflows) decrease plant assets. increased decreased u Accumulated depreciation is increased by the amount of depreciation expense and decreased by the removal of accumulated depreciation associated with plant assets that are sold. Plant Assets

48. Copyright © by Houghton Mifflin Company. All rights reserved.48 Plant Assets Cash Sale 10,000 Beg. Bal. 505,000 Cash Sale 10,000 Cash Purchase 120,000 Cash Purchase 120,000 Noncash Purchase 100,000 Noncash Purchase 100,000 End. Bal. 715,000 Accumulated Depreciation Sale 2,000 Sale 2,000 Beg. Bal. 68,000 Dep. Exp. 37,000 End. Bal. 103,000 Increaseof$35,000 Increaseof$210,000 Noncash Investing and Financing Transactions

49. Copyright © by Houghton Mifflin Company. All rights reserved.49 Cash Flows from Financing Activities u Analysis is similar to that of investing activities, including treatment of related gains or losses. u Accounts to be analyzed are short-term borrowings, long-term liabilities, and stockholders’ equity accounts. u Cash dividends from the statement of stockholders’ equity must also be considered.

50. Copyright © by Houghton Mifflin Company. All rights reserved.50 Accounting for Cash Flows from Financing Activities Bonds Payable Repayment 50,000 Noncash Issue 100,000 Repayment 50,000 Beg. Bal. 245,000 Noncash Issue 100,000 End. Bal. 295,000 Bonds Payable50,000 Cash 50,000 Cash 50,000 Repayment of bonds at Repayment of bonds at face value at maturity face value at maturity Increaseof$50,000

51. Copyright © by Houghton Mifflin Company. All rights reserved.51 Common Stock Common Stock Paid-in Capital in Excess of Par Value Beg. Bal 200,00 Beg. Bal. 115,000 Issue 76,000 Issues 74,000 End. Bal. 276,000 End Bal. 189,000 Cash 150,000 Paid-in Capital in Excess of Par Value 74,000 Common Stock76,000 Issued 15,200 shares of $5 par value common stock at a market price of $9.87 per share.

52. Copyright © by Houghton Mifflin Company. All rights reserved.52 Retained Earnings Dividends 8,000 Dividends 8,000 Beg. Bal. 132,000 Net Income 16,000 End. Bal. 140,000 Retained Earnings8,000 Cash 8,000 Cash 8,000 Paid cash dividends for 20x1 Paid cash dividends for 20x1 Increase of $8,000

53. Copyright © by Houghton Mifflin Company. All rights reserved.53Discussion Q. Q. What is the proper treatment on the statement of cash flows of a transaction in which a building that cost $50,000 with accumulated depreciation of $32,000 is sold for a loss of $5,000?

54. Copyright © by Houghton Mifflin Company. All rights reserved.54 A. A. A building that cost $50,000 with accumulated depreciation of $32,000 that is sold for a loss of $5,000 would result in a cash inflow of $13,000 (carrying value of $18,000 less loss of $5,000). The transaction should be shown as a sale of building for $13,000 in the investing activities section of the statement of cash flows. If the indirect method is used, the $5,000 loss should be added to net income to determine net cash flows from operating activities.

55. Copyright © by Houghton Mifflin Company. All rights reserved.55 OBJECTIVE 7 Use the indirect method to prepare a statement of cash flows. Compiling the Statement of Cash Flows

56. Copyright © by Houghton Mifflin Company. All rights reserved.56 Indirect Statement of Cash Flows Net IncomeXX Add, Decrease in Current Assets XX Increase in Current Liabilities XX Deduct, Decrease in Current Assets (XX) Increase in Current Liabilities (XX) Add, Non-cash Expenses XX Losses XX Deduct, Gains (XX) Net Cash Flows from Operating Activities XX

57. Copyright © by Houghton Mifflin Company. All rights reserved.57Discussion Q. Q. Assuming the indirect method is used to prepare the statement of cash flows, tell whether each of the following items would appear: (a) as cash flows from operating activities, (b) as cash flows from investing activities, (c) as cash flows from financing activities, (d) in the schedule of noncash investing and financing transactions, or (e) not at all. 1. Dividends paid. 2. Cash receipts from sales. 3. Decrease in accounts receivable. 4. Sale of plant assets. 5. Gain on sale of investment. 6. Issue of stock for plant assets. 7. Issue of common stock. 8. Net income. 1. Dividends paid. 2. Cash receipts from sales. 3. Decrease in accounts receivable. 4. Sale of plant assets. 5. Gain on sale of investment. 6. Issue of stock for plant assets. 7. Issue of common stock. 8. Net income.

58. Copyright © by Houghton Mifflin Company. All rights reserved.58 KEY: (a) as cash flows from operating activities, (b) as cash flows from investing activities, (c) as cash flows from financing activities, (d) in the schedule of noncash investing and financing transactions, or (e) not at all. 1.Dividends paid 2.Cash receipts from sales 3.Decrease in accounts receivable 4.Sale of plant assets 5.Gain on sale of investment 6.Issue of stock for plant assets 7.Issue of common stock 8.Net income 1.Dividends paid 2.Cash receipts from sales 3.Decrease in accounts receivable 4.Sale of plant assets 5.Gain on sale of investment 6.Issue of stock for plant assets 7.Issue of common stock 8.Net income Answers in Red = c = e = a = b = a = d = c =a=a

59. Copyright © by Houghton Mifflin Company. All rights reserved.59 SUPPLEMENTAL OBJECTIVE 8 Prepare a work sheet for the statement of cash flows. Preparing the Work Sheet

60. Copyright © by Houghton Mifflin Company. All rights reserved.60 The Work Sheet Approach u The work sheet approach is used for complex companies. u The indirect method of determining cash flows from operating activities is used because of its basis in changes in the balance sheet accounts.

61. Copyright © by Houghton Mifflin Company. All rights reserved.61 Analyzing the Changes in Balance Sheet Accounts u Record net income. u Account for changes in current assets and current liabilities. u Use the information about other transactions to account for changes in noncurrent accounts. u Reclassify any other income and expense items not already dealt with.

62. Copyright © by Houghton Mifflin Company. All rights reserved.62Discussion Q. Q. Why is the work sheet approach considered more compatible with the indirect method than with the direct method of determining cash flows from operations?

63. Copyright © by Houghton Mifflin Company. All rights reserved.63 A. A. The work sheet approach is more compatible with the indirect method than with the direct method because in both the indirect method and the work sheet approach, net income is adjusted for changes in the balance sheet accounts (instead of each item in the income statement being adjusted individually, as in the direct method).

64. Copyright © by Houghton Mifflin Company. All rights reserved.64 SUPPLEMENTAL OBJECTIVE 9 Use the direct method to determine cash flows from operating activities and prepare a statement of cash flows. The Direct Method of Preparing the Statement of Cash Flows

65. Copyright © by Houghton Mifflin Company. All rights reserved.65 Direct and Indirect Method u Only the “Operating Activities” section differs in presentation. u Net-cash provided by Operating Activities is the same. u “Investing” and “Financing” sections are the same.

66. Copyright © by Houghton Mifflin Company. All rights reserved.66 u Credit sales do not necessarily equal cash inflows because the collections of accounts receivable in any one accounting period are not likely to equal credit sales. u Accounts receivable issues. 4 Some A/R may be uncollectible. 4 Prior period sales may be collected in the current period. 4 Current period sales may be collected in the next period. Cash Receipts from Sales

67. Copyright © by Houghton Mifflin Company. All rights reserved.67 increases u If A/R increases from one period to the next: 4 Cash receipts from sales < sales decreases u If A/R decreases from one period to the next: 4 Cash receipts from sales > sales + Decrease in A/R or u Cash Receipts from Sales = Sales or - Increase in A/R Accounts Receivable {

68. Copyright © by Houghton Mifflin Company. All rights reserved.68 Direct Method of Determining Net Cash Flows from Operating Activities

69. Copyright © by Houghton Mifflin Company. All rights reserved.69 u Most closely associated with investment activity u Often called investment income u But classified by the FASB as operating activities Cash Receipts from Interest and Dividends

70. Copyright © by Houghton Mifflin Company. All rights reserved.70 u Requires two adjustments. 1.Cost of goods sold must be adjusted for changes in inventory to arrive at net purchases. 2.Net purchases must be adjusted for the change in A/P to arrive at cash payments for purchases. Cash Payments for Purchases

71. Copyright © by Houghton Mifflin Company. All rights reserved.71 increased u If inventory has increased from period to period: 4 Net purchases > cost of goods sold. decreased u If inventory has decreased from period to period: 4 Net purchases < cost of goods sold. increased: u If accounts payable has increased: 4 Cash payments for purchases < purchases. decreased: u If accounts payable has decreased: 4 Cash payments for purchases > purchases. Cash Payments for Purchases and Cost of Goods Sold

72. Copyright © by Houghton Mifflin Company. All rights reserved.72 4 Possible situations: 1. CPP = CGS + Increase in Inventory + Decrease in A/ 2. CPP = CGS - Decrease in Inventory - Increase in A/P 3. CPP = CGS + Increase in Inventory – Increase in A/P 4. CPP = CGS – Decrease in Inventory + Decrease in A/P Relationships Between Cash Payments for Purchases and Cost of Goods Sold

73. Copyright © by Houghton Mifflin Company. All rights reserved.73 u Three adjustments must be made to arrive at cash flows: 1.Changes in prepaid expenses. 2.Changes in accrued liabilities. 3.Expenses that do not require a current outlay of cash. Cash Payments for Operating Expenses

74. Copyright © by Houghton Mifflin Company. All rights reserved.74 Changes in Prepaid Expenses increase, u As prepaid expenses increase, more cash will have been paid out than appears on the income statement as expenses. decrease, u As prepaid expenses decrease, expenses shown on the income statement will exceed the cash spent.

75. Copyright © by Houghton Mifflin Company. All rights reserved.75 increase, u As accrued liabilities increase, operating expenses on the income statement will exceed the cash spent. decrease, u As accrued liabilities decrease, operating expenses on the income statement will fall short of the cash spent. Changes in Accrued Liabilities

76. Copyright © by Houghton Mifflin Company. All rights reserved.76 u Depreciation, depletion, and amortization expenses must be subtracted from operating expenses to arrive at cash outflow. Expenses That Do Not Require a Current Outlay of Cash

77. Copyright © by Houghton Mifflin Company. All rights reserved.77 CPOE = OE + Increase in PPE + Decrease in AL - NCE CPOE = OE - Decrease in PPE - Increase in AL - NCE OE = Operating Expenses PPE = Prepaid Expenses AL = Accrued Liabilities NCE = Noncash Expenses Cash Payments for Operating Expenses

78. Copyright © by Houghton Mifflin Company. All rights reserved.78 Classified by the FASB as operating activities, rather than financing activities, because interest expense is a cost of operating a business. Cash Payments for Interest

79. Copyright © by Houghton Mifflin Company. All rights reserved.79 u The amount of income taxes expense shown on the income statement rarely equals the amount of income taxes actually paid during the year. u To determine cash payments for income taxes, income taxes (from the income statement) is adjusted by the change in Income Taxes Payable. increases, u If ITP increases, cash payments for income taxes will be less than the expense shown on the income statement. decreases, u If ITP decreases, cash payments for income taxes will exceed income taxes on the income statement. Cash Payments for Income Taxes

80. Copyright © by Houghton Mifflin Company. All rights reserved.80 Cash Payments for Income Taxes CPIT = IT + Decrease in Income Taxes Payable CPIT = IT - Increase in Income Taxes Payable

81. Copyright © by Houghton Mifflin Company. All rights reserved.81 Direct Statement of Cash Flows Cash Receipts from Sales XX Other Receipts XX Cash Payments for Purchases (XX) Operating Expenses(XX) Interest(XX) Income Taxes(XX) XX Net Cash Flows from Operating Activities XX

82. Copyright © by Houghton Mifflin Company. All rights reserved.82 u The FASB states that, when the Direct Method is used for the Statement of Cash Flows, a schedule must be provided that reconciles Net Income to Net Cash Flows from Operating Activities. (the Indirect Method.)

83. Copyright © by Houghton Mifflin Company. All rights reserved.83Discussion Q. Q. Why must depreciation, amortization, and depletion be subtracted from operating expenses when computing cash payments for operating expenses? A. A. The three expenses are legitimate accrual- based expenses, but they do not represent cash disbursements; they are merely paper allocations of cost. They must be eliminated in converting from an accrual to a cash basis.

84. Copyright © by Houghton Mifflin Company. All rights reserved.84 cashcash equivalents. 1.Describe the statement of cash flows, and define cash and cash equivalents. 2.State the principal purposes and uses of the statement of cash flows. 3.Identify the principal components of the classifications of cash flows, and state the significance of noncash investing and financing transactions. OK, LET’S REVIEW...

85. Copyright © by Houghton Mifflin Company. All rights reserved.85 4.Analyze the statement of cash flows. 5.Use the indirect method to determine cash flows from operating activities. 6.Determine cash flows from investing activities and financing activities. CONTINUING OUR REVIEW...

86. Copyright © by Houghton Mifflin Company. All rights reserved.86 7.Use the indirect method to prepare a statement of cash flows. 8.Prepare a work sheet for the statement of cash flows. 9.Use the direct method to determine cash flows from operating activities and prepare a statement of cash flows. AND FINALLY...