Chapter 16 Statement of Cash Flows Accounting, 21 st Edition Warren Reeve Fess PowerPoint Presentation by Douglas Cloud Professor Emeritus of Accounting Pepperdine University © Copyright 2004 South-Western, a division of Thomson Learning. All rights reserved. Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.

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1.Summarize the types of cash flow activities reported in the statement of cash flows. 2.Prepare a statement of cash flows, using the indirect method. 3.Prepare a statement of cash flows, using the direct method. 4.Calculate and interpret the free cash flow. ObjectivesObjectives After studying this chapter, you should be able to:

The statement of cash flows reports cash flows by three types of activities: 1. Cash flows from operating activities – transactions that affect net income. 2.Cash flows from investing activities – transactions that affect noncurrent assets. 3.Cash flows from financing activities – transactions that affect equity and debt of the entity. Reporting Cash Flows

(payments for expenses) Operating Operating Increases in Cash Decreases in Cash (receipts from sales of noncurrent assets) Investing Investing (receipts from issuing equity and debt securities) Financing Financing (payments for acquiring noncurrent assets) Investing Investing Reporting Cash Flows (receipts from revenues) Operating Operating (payments for treasury stock, dividends, and redemption of debt securities) Financing Financing

Typical cash inflows Typical cash outflows What are some of the typical cash inflows from operating activities?` Cash Flows from Operating Activities Interest revenue Sales of goods and services Dividend revenue What are some of the typical cash outflows from operating activities? Merchandise purchases Payments of wages and other expenses Tax payments

What are some of the typical cash inflows from investing activities? Typical cash inflows Typical cash outflows Sale of long- term investments Sales of fixed assets Purchase of fixed assets Purchase of long-term investments What are some of the typical cash outflows from investing activities? Cash Flows from Investing Activities

Cash Flows from Financing Activities What are some of the typical cash inflows from financing activities? Issuing preferred and common stock Issuing bonds and long-term notes payable Paying cash dividends Repaying debt What are some of the typical cash outflows from financing activities? Acquiring treasury stock Typical cash inflows Typical cash outflows

Noncash Investing and Financing Activities Issuing bonds to acquire land Issuing common stock for convertible preferred stock Issuing a long-term note to acquire equipment Issuing a stock dividend

No cash flow per share is reported in the financial statements because the user might incorrectly interpret this as the amount available for dividends.

Balance Sheet Assets = Liabilities + Stockholders’ Equity Cash + Noncash Assets = Liabilities + Stockholders’ Equity Cash = Liabilities + Stockholders’ Equity – Noncash Assets Cash Liabilities Stockholders’Equity NoncashAssets The Indirect Method

Cash Liabilities Stockholders’Equity Balance Sheet NoncashAssets Assets = Liabilities + Stockholders’ Equity Cash + Noncash Assets = Liabilities + Stockholders’ Equity Cash = Liabilities + Stockholders’ Equity – Noncash Assets 23 1 The cash flows are determined by analyzing liabilities, stockholders’ equity, and noncash assets. The Indirect Method

Start with the accrual basis net income (shown in the income statement, the Retained Earnings account, or the statement of stockholders’ equity). The Indirect Method

Find the net income. ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit Jan.1Balance202,300 Dec.31Net income108,000310,300 31Cash dividends28,000282,300 To statement The Indirect Method 2006

Net income per income statement$108,000 Depreciation$ 7,000 Decrease in inventories8,000 Increase in accrued expenses 2,200 17,200 $125,200 Inc. in accounts receivable$ 9,000 Dec. in accounts payable3,200 Dec. in income taxes payable500 Gain on sale of land12,000 24,700 Net cash flow from operating activity $100,500 Cash flows from operating activities: Operating Activities – Indirect Method Deduct: Add :

Next, we need to determine depreciation expense for the year. If it isn’t given on the income statement, sometimes it can be found by analyzing the Accumulated Depreciation account. The Indirect Method

Determine depreciation expense. ACCOUNT Accumulated Depreciation--Building ACCOUNT NO. 17 Balance Date Item Debit Credit Debit Credit Jan.1Balance58,300 Dec.31Depreciation for year7,00065,300 to statement 2006 The Indirect Method

Cash flows from operating activities: Operating Activities – Indirect Method Deduct: Add : Net income per income statement$108,000 Depreciation$ 7,000 Decrease in inventories8,000 Increase in accrued expenses 2,200 17,200 $125,200 Inc. in accounts receivable$ 9,000 Dec. in accounts payable3,200 Dec. in income taxes payable500 Gain on sale of land12,000 24,700 Net cash flow from operating activities$100,500 Because Depreciation Expense reduced net income but did not require an outflow of cash, it is added back to net income.

Select current assets and current liabilities that impact cash flow and determine the increases and decreases. The Indirect Method

Determine the debit or credit change of each item above. Changes in Current Accounts Change Accounts DebitCredit Accounts receivable (net)$74,000$65,000 Inventories172,000180,000 Accounts payable (mdse.)43,50046,700 Accrued expenses payable26,50024,300 Income taxes payable7,9008,400 9,000 8,000 3,200 2,

Changes in Current Accounts Change Accounts DebitCredit Accounts receivable (net)$74,000$65,000 Inventories172,000180,000 Accounts payable (mdse.)43,50046,700 Accrued expenses payable26,50024,300 Income taxes payable7,9008,400 These debit changes are subtracted from net income in the operating activities section of the statement of cash flows. Think of these debits as deductions from net income in arriving at net cash flow from operations. 9,000 8,0003,200 2,200500

Changes in Current Accounts Change Accounts DebitCredit Accounts receivable (net)$74,000$65,000 Inventories172,000180,000 Accounts payable (mdse.)43,50046,700 Accrued expenses payable26,50024,300 Income taxes payable7,9008,400 9,0008,000 3,2002, These credit changes are added to net income in the operating activities section of the statement of cash flows. Think of these credits as additions to net income in arriving at net cash flow from operations.

Cash flows from operating activities: Operating Activities—Indirect Method Add : Net income per income statement$108,000 Depreciation$ 7,000 Decrease in inventories8,000 Increase in accrued expenses 2,200 Increase in accrued expenses 2,200 17,200 $125,200 Inc. in accounts receivable$ 9,000 Dec. in accounts payable3,200 Dec. in income taxes payable500 Gain on sale of land12,000 24,700 Net cash flow from operating activities$100,500

Analyze the income statement to determine if there are any gains or losses from selling investments, equipment, etc. The Indirect Method

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 Cost of merchandise sold 790,000 Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,000 Other operating expenses196,000 Total operating expenses 203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense 8,000 4,0000 Income before income tax$ 191,000 Income tax 83,000 Net income$ 108,000 Gain on sale of land $12,000

Cash flows from operating activities: Operating Activities—Indirect Method Add : Net income, per income statement$108,000 Depreciation$ 7,000 Decrease in inventories8,000 Increase in accrued expenses 2,200 17,200 $125,200 Inc. in accounts receivable$ 9,000 Dec. in accounts payable3,200 Dec. in income taxes payable500 Gain on sale of land12,000 24,700 Net cash flow from operating activities$100,500 This gain was included in net income, but did not represent an operating cash flow.

If there had been a loss on this sale, the loss would have been added to net income. The Indirect Method

Cash Flows from Financing Activities ACCOUNT Dividends Payable ACCOUNT NO. 23 Balance Date Item Debit Credit Debit Credit Jan.1Balance10,000 10Cash paid10, June 20Dividends declared14,00014,000 July10Cash paid14, Dec.20Dividends declared14,00014,000 Total cash paid$24,000 Dividends 2006

Cash Flows from Financing Activities Because paying of dividends affects equity, it is a negative $24,000 cash flow from financing activities transaction.

Cash Flows from Financing Activities Balance Date Item Debit Credit Debit Credit Jan.1Balance16,000 Nov. 14,000 shares issued for cash8,00024,000 Sale of Common Stock 2006 ACCOUNT Common Stock ACCOUNT NO. 33

Cash Flows from Financing Activities ACCOUNT Paid-In Capital in Excess of Par--Common ACCT. NO. 34 Balance Date Item Debit Credit Debit Credit Jan.1Balance80,000 Nov. 14,000 shares issued for cash40,000120,000 Sale of Common Stock 2006

Cash Flows from Financing Activities Issuing common stock affects equity; therefore, we have a total positive cash flow of $48,000 from this financing activities transaction.

Cash Flows from Financing Activities ACCOUNT Bonds Payable ACCOUNT. NO. 25 Balance Date Item Debit Credit Debit Credit Jan.1Balance150,000 June30Retired by payment of cash at face amount50,000100,000 Retirement of Bonds Payable 2006

Cash Flows from Financing Activities This transaction is a negative cash flows from financing activities item because long- term debt is involved.

ACCOUNT Building ACCOUNT NO. 18 Balance Date Item Debit Credit Debit Credit Jan.1Balance200,000 Dec.27Purchased for cash 60,000260, Cash Flows from Investing Activities Purchased a Building

Cash Flows from Investing Activities Purchasing a building involves a noncurrent asset, so this is a negative cash flows from investing activities item. Purchased a Building

Cash Flows from Investing Activities ACCOUNT Land ACCOUNT NO. 16 Balance Date Item Debit Credit Debit Credit Jan.1Balance125,000 June8Sold for $72,000 cash60,00065,000 Oct.12Purchased for $15,000 cash 15,00080,000 Land Transactions 2006

Cash Flows from Investing Activities The first transaction, the sale of land, results in a positive cash flow from investing activities because land is a noncash asset. Land Transactions

Cash Flows from Investing Activities The $12,000 gain was recorded earlier on Slide 29 as an operating activity. The purchase of land also is an investing activity. Click here to return to Slide 29. To return to this slide, type “43” and press the “Enter” key. Land Transactions

Refer to Exhibit 6 in your textbook to see the formal statement of cash flows using the indirect approach.

Sales$1,180,000 Cost of merchandise sold 790,000 Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,000 Other operating expenses196,000 Total operating expenses 203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense 8,000 4,000 Income before income tax$ 191,000 Income tax83,000 Net income$ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2006 This is an accrual basis income statement. The direct method of reporting cash flows will essentially convert this to a cash basis statement. This is an accrual basis income statement. The direct method of reporting cash flows will essentially convert this to a cash basis statement. Cash Basis

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 Cost of merchandise sold790,000 Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,000 Other operating expenses196,000 Total operating expenses203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense 8,000 4,000 Income before income tax$ 191,000 Income tax 83,000 Net income$ 108,000 Debit Credit Changes Cash collected from customers Note: The changes in the current balance sheet accounts are determined by comparing the beginning and ending balances. Receivables increased by $9,000 during the period. Sales1,180,000 Receivables 9,000 Cash Basis

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 Cost of merchandise sold790,000 Gross profit$390,000 Operating expenses: Depreciation expense$ 7,000 Other operating expenses196,000 Total operating expenses203,000 Income from operations$187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense8,0004,000 Income before income tax$ 191,000 Income tax83,000 Net income$ 108,000 Cash collected from customers The increase in receivables represents a reduction in cash inflow relative to the accrual revenue reported on the income statement. $1,171,000 Cash 1,171,000 Sales1,180,000 Receivables 9,000 Changes Debit Credit Cash Basis

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 $1,171,000 Cost of merchandise sold790,000 Gross profit$390,000 Operating expenses: Depreciation expense$ 7,000 Other operating expenses196,000 Total operating expenses203,000 Income from operations$187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense8,0004,000 Income before income tax$ 191,000 Income tax83,000 Net income$ 108,000 Debit Credit Cost of mdse. sold790,000 Inventories8,000 Accounts payable3,200 Cash Changes Cash payments for merchandise Cash Basis

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 $1,171,000 Cost of merchandise sold790,000 Gross profit$390,000 Operating expenses: Depreciation expense$ 7,000 Other operating expenses196,000 Total operating expenses203,000 Income from operations$187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense8,0004,000 Income before income tax$ 191,000 Income tax83,000 Net income$ 108,000 Debit Credit Cost of mdse. sold790,000 Inventories8,000 Accounts payable3,200 Cash 785,200 Changes Cash payments for merchandise (785,200) A decrease in Inventories (credit change) and an decrease in Accounts Payable (debit change) have the opposite effects. Cash Basis minus plus

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 $1,171,000 Cost of merchandise sold790,000(785,200) Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,000 Other operating expenses196,000 Total operating expenses203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense 8,000 4,000 Income before income tax$ 191,000 Income tax83,000 Net income$ 108,000 Debit Credit Depreciation expense7,000 Accumulated depreciation7,000 ChangesDepreciation There is no cash flow for depreciation expense. 0 Cash Basis

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 $1,171,000 Cost of merchandise sold790,000(785,200) Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,0000 Other operating expenses196,000 Total operating expenses203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense8,0004,000 Income before income tax$ 191,000 Income tax83,000 Net income$ 108,000 Changes Debit Credit Operating expenses196,000 Accrued expenses2,200 Cash Changes Cash payments for operating expenses 193,800 (193,800) Cash Basis minus

Sales$1,180,000 $1,171,000 Cost of merchandise sold790,000(785,200) Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,0000 Other operating expenses196,000(193,800) Total operating expenses 203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense 8,000 4,000 Income before income tax$ 191,000 Income tax 83,000 Net income$ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2006 Debit Credit Cash72,000 Investments60,000 Gain on sale of invest.12,000 Changes Gain on sale of investments 0 The cash inflow of $72,000 will be shown in the investing section of the statement of cash flows and the gain is ignored. Cash Basis

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales $1,180,000 $1,171,000 Cost of merchandise sold 790,000(785,200) Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,0000 Other operating expenses196,000(193,800) Total operating expenses203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 0 Other expense: Interest expense8,0004,000 Income before income tax$ 191,000 Income tax83,000 Net income$ 108,000 Debit Credit Interest expense Cash Changes Cash paid for interest expense 8,000 (8,000) There is no interest payable account at the end of the year. Cash Basis

Sales$1,180,000 $1,171,000 Cost of merchandise sold 790,000(785,200) Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,0000 Other operating expenses196,000(193,800) Total operating expenses 203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,000 Other expense: Interest expense 8,000 4,000(8,000) Income before income tax$ 191,000 Income tax 83,000 Net income$ 108,000 Rundell Inc. Income Statement For the Year Ended December 31, 2006 Debit Credit Income tax expense Income tax payable500 Cash Changes Cash paid for income taxes 83,000 (83,500) Cash Basis plus

Rundell Inc. Income Statement For the Year Ended December 31, 2006 Sales$1,180,000 $1,171,000 Cost of merchandise sold790,000(785,200) Gross profit$ 390,000 Operating expenses: Depreciation expense$ 7,0000 Other operating expenses196,000(193,800) Total operating expenses203,000 Income from operations$ 187,000 Other income: Gain on sale of land$12,0000 Other expense: Interest expense 8,000 4,000(8,000) Income before income tax$ 191,000 Income tax83,000(83,500) Net income$ 108,000$ 100,500 Two different viewpoints of income from operations Two different viewpoints of income from operations Cash Basis Accrual Basis Cash Basis

Cash flows from operating activities: Operating Activities—Direct Method Cash inflows: Cash received from customers$1,171,000 Cash outflows: Cash payments for merchandise$785,200 Cash payments for operating expenses193,800 Cash payments for interest8,000 Cash payments for income tax 83,5001,070,500 Net cash flow from operating activities$ 100,500

Financial Analysis and Interpretation Free Cash Flow Free Cash Flow Cash flow from operations$4,195,000 Less: Cash used to purchase fixed assets to maintain productive capacity used up in producing income during the period(482000) Less: Cash used for dividends—– Free cash flow$3,713,000 Free cash flow as a percent of cash flow from operating activities89% Dell Corporation

Financial Analysis and Interpretation Free Cash Flow Free Cash Flow Cash flow from operations$4,195,000 Less: Cash used to purchase fixed assets to maintain productive capacity used up in producing income during the period(482000) Less: Cash used for dividends(—) Free cash flow$3,713,000 Free cash flow as a percent of cash flow from operations89% Dell Corporation Use:To measure the financial strength of a business. A company that has positive free cash flow is able to fund internal growth, retire debt, and enjoy financial flexibility.

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