1. TENTH CANADIAN EDITION INTERMEDIATE ACCOUNTING Prepared by: Lisa Harvey, CPA, CA Rotman School of Management, University of Toronto 22 CHAPTER 22 Statement of Cash Flows Kieso Weygandt Warfield Young Wiecek McConomy

2. CHAPTER Copyright © John Wiley & Sons Canada, Ltd. 22 After studying this chapter, you should be able to: Understand the importance of cash flows from a business perspective. Describe the purpose and uses of the statement of cash flows. Define cash and cash equivalents. Identify the major classifications of cash flows and explain the significance of each classification. Prepare the operating activities section of a statement of cash flows using the direct versus the indirect method. Prepare a statement of cash flows using the direct method. Prepare a statement of cash flows using the indirect method. Identify the financial presentation and disclosure requirements for the statement of cash flows. Read and interpret a statement of cash flows. Identify differences in ASPE and IFRS, and explain what changes are expected to standards for the statement of cash flows. STATEMENT OF CASH FLOWS 2

3. 3 Copyright © John Wiley & Sons Canada, Ltd. Statement of Cash Flows 3 Introduction to the Statement of Cash Flows Cash flows from a business perspective Purpose and usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/ASPE Comparison Comparison of IFRS and ASPE Looking ahead Preparing a Statement of Cash Flows First illustration using the direct method – Tax Consultants Inc. Second illustration using the indirect method – Eastern Window Products Limited Third illustration using both methods – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative example Interpreting the statement of cash flows Free cash flow

4. 4 Copyright © John Wiley & Sons Canada, Ltd. Cash Flows from a Business Perspective A lack of cash flow is one of the main causes of bankruptcy –A sign of a healthy company is positive cash flows from operations Over the years, the statement of cash flows has grown in importance –Helps users answer many questions such as: Will the company be able to pay dividends? How was the acquisition of the new subsidiary financed?

5. 5 Copyright © John Wiley & Sons Canada, Ltd. Purpose and Usefulness of the Statement of Cash Flows The information helps users (investors, creditors, and others) assess the following: 1.Liquidity and solvency – i.e., the entity’s ability to generate future cash flows and its needs for cash resources 2.The amounts, timing, and uncertainty of future cash flows 3.The reasons why net income and net cash flow from operating activities differ 5

6. 6 Copyright © John Wiley & Sons Canada, Ltd. Cash and Cash Equivalents Cash Cash on hand Demand deposits Cash Equivalents Investments that are –Short term, –Highly liquid, and –Easily converted to a known amount of cash –Subject to an insignificant risk of change in value 6 All references to Cash include Cash Equivalents when discussing the Statement of Cash Flows

7. 7 Copyright © John Wiley & Sons Canada, Ltd. The Cash Flow Statement The cash flow statement provides information about: the cash receipts (cash inflows), and uses of cash (cash outflows) during the year Inflows and outflows are reported for: operating activities investing activities, and financing activities during the year 7

8. 8 Copyright © John Wiley & Sons Canada, Ltd. Classification of Cash Flows 1.Operating Activities The cash flows resulting from the primary revenue- producing activities of the business such as: Collections from customers Payments to suppliers Payments to Canada Revenue Agency (CRA) for tax Payments to employees Cash flow provided by operating activities is necessary for long term sustainability of the business (i.e. to take advantage of new investment opportunities, to pay dividends without seeking external financing etc.) 8

9. 9 Copyright © John Wiley & Sons Canada, Ltd. Classification of Cash Flows 2.Investing Activities The acquisition and disposal of long term assets and long-term investments such as: Making and collecting loans Acquiring and disposing of investments Purchase/disposal of long-lived assets Cash flow generated by investing activities shows if the business is investing in additional long term assets that will generate profits and increase cash flows in the future 9

10. 10 Copyright © John Wiley & Sons Canada, Ltd. Classification of Cash Flows 3.Financing Activities Changes in long-term debt or equity capital such as: Issuing or repayment of debt Issuing new shares or repurchase of currently outstanding shares Provides information to assess potential for future claims to entity’s cash and major changes in the form of financing 10

11. 11 Copyright © John Wiley & Sons Canada, Ltd. Statement of Cash Flows: Concept 11 Operating activities Investing activities Financing activities Inflows Cash Pool Operating activities Investing activities Financing activities Outflows

12. 12 Copyright © John Wiley & Sons Canada, Ltd. Classification of Cash Flows IFRS requirements relating to classification of cash flows are similar to ASPE except for the following: 12

13. 13 Copyright © John Wiley & Sons Canada, Ltd. Classification of Cash Flows Income statement gains and losses on disposal of long-term assets must be adjusted in determining cash flows from operations –These result from investing activities, not operating activities –The amount of the cash flow is the proceeds on disposal not the gain or loss included in income 13

14. 14 Copyright © John Wiley & Sons Canada, Ltd. Classification of Cash Flows Income statement gains and losses on redemption of long-term debt must be adjusted in determining cash flows from operations –These result from financing activities, not operating activities, and –The amount of the cash flow is the amount paid to redeem the debt not the gain or loss included in income 14

15. 15 Copyright © John Wiley & Sons Canada, Ltd. Significant Non-Cash Transactions Transactions that do not involve the direct receipt or disbursement of cash in the period such as: –Asset purchased and paid for by assuming debt, or issuance of shares –Exchanges of non-monetary assets –Conversion of debt to equity –Issuance of shares to retire debt Non-cash transactions are not reported on the Statement of Cash Flows If material, they are reported as notes to the statement or in a supplementary schedule to the financial statements 15

16. 16 Copyright © John Wiley & Sons Canada, Ltd. Format of the Statement of Cash Flows Two methods of preparing the operating cash flow section of the Statement of Cash Flows: 1.Indirect method Derives operating cash flows from accrual basis income statement 2.Direct method Determines operating cash flows directly for each operating source or use of cash 16

17. 17 Copyright © John Wiley & Sons Canada, Ltd. The Indirect Method 17 Net Income + - Earned Revenues Expenses Incurred Operating cash flow Eliminate non-cash revenues Eliminate non-cash charges

18. 18 Copyright © John Wiley & Sons Canada, Ltd. The Indirect Method 18 Accrual Basis StatementsCash Flow Statement Income Statement items and changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals, non-cash charges and non- operating gains/losses Balance Sheet: Changes in Non-Current Assets Investing activities: Inflows from sale of assets and outflows for purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities: Inflows and outflows from loan and equity transactions

19. 19 Copyright © John Wiley & Sons Canada, Ltd. Format of the Statement of Cash Flows (Indirect Method) 19 Cash flows from operating activities: Net Income (Loss) $ XXX Adjustments (List individual adjustments) $ XX Net cash flow from operating activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Change in cash $ XXX

20. 20 Copyright © John Wiley & Sons Canada, Ltd. The Direct Method Received from customers for cash sales and on account Cash receipts from other revenue sources 20 OutflowsInflows Paid to suppliers for cash purchases and payments on account Paid to employees for salaries and wages Paid to government for taxes

21. 21 Copyright © John Wiley & Sons Canada, Ltd. Format of the Statement of Cash Flows (Direct Method) 21 Cash flows from operating activities: Cash receipts (separately): inflows $ XXX Cash payments (separately): outflows ($ XXX) Net cash flow from operating activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Change in cash $ XXX

22. 22 Copyright © John Wiley & Sons Canada, Ltd. Format of the Statement of Cash Flows Both IFRS and ASPE encourage the use of the direct method as it provides additional information –Is more consistent with the objective of the statement of cash flows –Information about specific sources of cash inflows and purposes of cash outflows helps in estimating future cash flows Lending officers and other investors also prefer the direct method 22

23. 23 Copyright © John Wiley & Sons Canada, Ltd. Statement of Cash Flows 23 Introduction to the Statement of Cash Flows Cash flows from a business perspective Purpose and usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/ASPE Comparison Comparison of IFRS and ASPE Looking ahead Preparing a Statement of Cash Flows First illustration using the direct method – Tax Consultants Inc. Second illustration using the indirect method – Eastern Window Products Limited Third illustration using both methods – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative example Interpreting the statement of cash flows Free cash flow

24. 24 Copyright © John Wiley & Sons Canada, Ltd. Direct Method - Example Given: Tax Consultants Inc. began operations on January 1, 2013 24 Income Statement For the year ended December 31, 2014 Revenues $ 125,000 Operating expenses 85,000 Income before income taxes 40,000 Income tax expense 6,000 Net Income $ 34,000

25. 25 Copyright © John Wiley & Sons Canada, Ltd. Direct Method - Example 25 Comparative Statement of Financial Position Dec 31, 2014 Dec 31, 2013 Assets: Cash$ 89,000 $ 40,000 Accounts receivable 66,000 30,000 Total $155,000 $ 70,000 Liabilities and Shareholders’ Equity: Accounts payable $ 35,000 $ 30,000 Common shares 80,000 20,000 Retained earnings 40,000 20,000 Total$155,000 $ 70,000

26. 26 Copyright © John Wiley & Sons Canada, Ltd. Direct Method – Example Operating Cash Flows 26 Accounts Receivable increased by $36,000 Cash collections are less than revenue recognized Reduce revenue from credit sales by $36,000 to derive cash flows from operations

27. 27 Copyright © John Wiley & Sons Canada, Ltd. Direct Method – Example Operating Cash Flows 27 Accounts Payable increased by $5,000 Cash paid for purchases is less than COGS reported Increase COGS by $5,000 to derive cash flows from operations

28. 28 Copyright © John Wiley & Sons Canada, Ltd. Direct Method – Example Operating Cash Flows 28 Cash receipts from customers: = Revenue from credit sales – increase in A/R balance = $125,000 – $36,000 = $89,000 Cash payments to suppliers: = Cost of goods sold – increase in A/P balance = $85,000 – $5,000 = $80,000

29. 29 Copyright © John Wiley & Sons Canada, Ltd. Direct Method – Example Operating Cash Flows Operating Activities: Cash received from customers $89,000 Cash paid to suppliers (80,000) Cash paid for income taxes (6,000) Net cash inflow $ 3,000 29

30. 30 Copyright © John Wiley & Sons Canada, Ltd. Investing and Financing Cash Flows 30 Accrual Basis Common stock + $60,000 Retained earnings +$20,000 Beg. Balance:$ 0 Net Income: 34,000 less: Dividends (14,000) End Balance: $20,000 Cash Flow Financing Activities: Issue of Shares: $60,000 Dividends paid: (14,000) Inflow 46,000

31. 31 Copyright © John Wiley & Sons Canada, Ltd. Direct Method – Example Summary Cash provided by operating activities: Cash received from customers $ 89,000 Cash paid to suppliers (80,000) Cash paid for income taxes (6,000) 3,000 Cash used by investing activities: -0- Cash provided by financing activities: 46,000 Net inflow for the year 49,000 Beginning cash balance: 40,000 Cash, end of year $ 89,000 31

32. 32 Copyright © John Wiley & Sons Canada, Ltd. Indirect Method - Example Given: Same information for Tax Consultants Inc. given for the direct method example Determine cash flows from operating activities (cash flows from investing and financing activities remain the same) 32

33. 33 Copyright © John Wiley & Sons Canada, Ltd. Indirect Method – Example Operating Activities 33 Net Income $34,000 Accounts Receivable +$ 36,000 Accounts Payable +$ 5,000 Accrual Basis Net Income $34,000 Less: Increase in A/R $ 36,000 Add: Increase in A/P $ 5,000 Cash Flow Operations: Net Inflow $3,000

34. 34 Copyright © John Wiley & Sons Canada, Ltd. Statement of Cash Flows 34 Introduction to the Statement of Cash Flows Cash flows from a business perspective Purpose and usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/ASPE Comparison Comparison of IFRS and ASPE Looking ahead Preparing a Statement of Cash Flows First illustration using the direct method – Tax Consultants Inc. Second illustration using the indirect method – Eastern Window Products Limited Third illustration using both methods – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative example Interpreting the statement of cash flows Free cash flow

35. 35 Copyright © John Wiley & Sons Canada, Ltd. Disclosure Requirements IFRS and ASPE require similar disclosures on certain items, including the disclosure of: 1.Significant non-cash investing and financing transactions 2.Policy on what makes up cash and cash equivalents 3.Reconciliation of cash and cash equivalents to balance sheet accounts IFRS has more strict requirements relating to disclosure of some items, including: 1.Income taxes 2.Interest and dividends (paid and received) 3.Restrictions on cash and cash equivalents 35

36. 36 Copyright © John Wiley & Sons Canada, Ltd. Free Cash Flow Free cash flow (FCF) is a non-GAAP measure used by many companies to indicate discretionary cash available for new investments, paying dividends, retiring debt, repurchasing shares, or improving liquidity FCF is typically calculated as: –Net operating cash flows –Less: capital expenditures to sustain current level operations As it is a non-GAAP measure, some companies calculate FCF differently 36

37. 37 Copyright © John Wiley & Sons Canada, Ltd. Statement of Cash Flows 37 Introduction to the Statement of Cash Flows Cash flows from a business perspective Purpose and usefulness of the statement What is cash? Classification of cash flows Format of the statement IFRS/ASPE Comparison Comparison of IFRS and ASPE Looking ahead Preparing a Statement of Cash Flows First illustration using the direct method – Tax Consultants Inc. Second illustration using the indirect method – Eastern Window Products Limited Third illustration using both methods – Yoshi Corporation Presentation, Disclosure, and Analysis Disclosure requirements Presentation Illustrative example Interpreting the statement of cash flows Free cash flow

38. 38 Copyright © John Wiley & Sons Canada, Ltd. Looking Ahead Significant changes are expected from the FASB-IASB Financial Statement Presentation project Both IAS 1 Presentation of Financial Statements and IAS 7 Statement of Cash Flows are expected to be replaced with a new standard 38

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