Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Prepared by: Debbie Musil Kwantlen Polytechnic University Chapter 17 The Cash Flow Statement

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. The Cash Flow Statement Reporting of cash flows Reporting of cash flows Purpose and content of the cash flow statementPurpose and content of the cash flow statement Preparing the cash flow statement Preparing the cash flow statement Operating activitiesOperating activities Investing activitiesInvesting activities Financing activitiesFinancing activities The cash flow statementThe cash flow statement Using financial statement information Using financial statement information Free cash flowFree cash flow

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Purpose of the Cash Flow Statement Gives information about: Gives information about: Cash receipts and paymentsCash receipts and payments Net change in cash during a periodNet change in cash during a period Helps investors, creditors and others understand a company’s: Helps investors, creditors and others understand a company’s: Ability to generate future cash flowsAbility to generate future cash flows Ability to pay dividends and meet obligationsAbility to pay dividends and meet obligations Investing and financing activities during periodInvesting and financing activities during period Cash provided (used) by operating activities, and how it differs from profitCash provided (used) by operating activities, and how it differs from profit

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Content of Cash Flow Statement: Definition of Cash Cash flow statement is prepared using cash and cash equivalents: Cash flow statement is prepared using cash and cash equivalents: Highly liquid investments readily convertible to cash, andHighly liquid investments readily convertible to cash, and Very near maturity (usually three months)Very near maturity (usually three months) Companies must give a clear definition of “cash” as it is used in the statement Companies must give a clear definition of “cash” as it is used in the statement

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Content of Cash Flow Statement: Classification of Cash Flows Operating activities: cash effect of transactions: Operating activities: cash effect of transactions: That create revenues and expensesThat create revenues and expenses That affect current assets and liabilitiesThat affect current assets and liabilities Investing activities: affect long-term assets: Investing activities: affect long-term assets: Acquiring and disposing of investments and long-lived assets, andAcquiring and disposing of investments and long-lived assets, and Lending money and collecting the loansLending money and collecting the loans Financing activities: affect long-term liability and shareholders’ equity accounts: Financing activities: affect long-term liability and shareholders’ equity accounts: Proceeds from issuing debt and repayment of debtProceeds from issuing debt and repayment of debt Proceeds from shareholders and payment of dividendsProceeds from shareholders and payment of dividends

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Content of Cash Flow Statement: Significant Noncash Activities Significant investing and financing activities not affecting cash are not reported in cash statement Significant investing and financing activities not affecting cash are not reported in cash statement Reported in a separate note insteadReported in a separate note instead Examples: Examples: Issue of debt to purchase assetsIssue of debt to purchase assets Issue of common shares to purchase assetsIssue of common shares to purchase assets Conversion of debt or preferred shares to common sharesConversion of debt or preferred shares to common shares Exchanges of property, plant and equipmentExchanges of property, plant and equipment

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Preparation of the Cash Flow Statement Cash flow statement is prepared differently from other financial statements Cash flow statement is prepared differently from other financial statements Not prepared from the adjusted trial balance Not prepared from the adjusted trial balance Information usually comes from three sources: Information usually comes from three sources: Comparative balance sheetComparative balance sheet Current income statementCurrent income statement Additional informationAdditional information Accrual concept is not used, since cash flow statement deals with cash receipts and payments Accrual concept is not used, since cash flow statement deals with cash receipts and payments

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Four Steps to Preparing the Cash Flow Statement Determine net cash provided (used) by: 1.Operating activities: convert profit from accrual basis to cash basis 2.Investing activities: analyze changes in long- term asset accounts 3.Financing activities: analyze changes in long- term liability and equity accounts Then: 4. Prepare cash flow statement and determine net increase (decrease) in cash

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Convert profit from accrual to cash basis Convert profit from accrual to cash basis Some revenues and expenses have not been realized or paid in cash, therefore cannot be included in cash statementSome revenues and expenses have not been realized or paid in cash, therefore cannot be included in cash statement Two methods to convert: indirect and direct: Two methods to convert: indirect and direct: Indirect (more popular): total profit is convertedIndirect (more popular): total profit is converted Direct: individual revenues and expenses are convertedDirect: individual revenues and expenses are converted Both methods arrive at the same total amount; difference is in the amount of disclosureBoth methods arrive at the same total amount; difference is in the amount of disclosure

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Indirect Method Add non-cash expenses (e.g. depreciation) Add non-cash expenses (e.g. depreciation) Add losses and deduct gains Add losses and deduct gains From investing and financing activitiesFrom investing and financing activities Changes in noncash current assets and liabilities: Changes in noncash current assets and liabilities: Add: decreases in current assets and increases in current liabilitiesAdd: decreases in current assets and increases in current liabilities Deduct: increases in current assets and decreases in current liabilitiesDeduct: increases in current assets and decreases in current liabilities ± = Adjustments Profit Net cash provided (used) by operating activities

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Indirect Method 2

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Summary of Indirect Method Starting with profit, add and deduct these items to arrive at net cash provided (used) by operations: Starting with profit, add and deduct these items to arrive at net cash provided (used) by operations: Noncash expensesNoncash expenses Gains and losses, andGains and losses, and Changes in noncash current asset and liability accountsChanges in noncash current asset and liability accounts

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Direct Method Each revenue and expense item is adjusted from accrual basis to cash basis Each revenue and expense item is adjusted from accrual basis to cash basis By adjusting for changes in the related asset and liability accountsBy adjusting for changes in the related asset and liability accounts Only major classes of receipts and payments are reported Only major classes of receipts and payments are reported

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Direct Method 2

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Direct Method: Receipts and Payments Cash Receipts from Customers: Decrease in receivables: cash collected Decrease in receivables: cash collected Increase in receivables: cash receipts lower than revenues Increase in receivables: cash receipts lower than revenues Cash Payments to Suppliers: First determine cost of goods purchased = cost of goods sold ± changes in inventory First determine cost of goods purchased = cost of goods sold ± changes in inventory Then determine cash payments by adjusting cost of goods purchased for changes in accounts payable Then determine cash payments by adjusting cost of goods purchased for changes in accounts payable = Revenue Cash receipts from customers + Decrease in accounts receivable - Increase in accounts receivable or

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Direct Method: Cash Payments Cash Payments to Suppliers (continued): Cash Payments for Operating Expenses: Increase in prepaid expenses and decrease in accrued liabilities: more cash paid Increase in prepaid expenses and decrease in accrued liabilities: more cash paid Decrease in prepaid expenses and increase in accrued liabilities: less cash paid Decrease in prepaid expenses and increase in accrued liabilities: less cash paid = Cost of goods sold Cash payments to suppliers + Decrease in accounts payable - Increase in accounts payable or + Increase in inventory - Decrease in inventory or = Operating expenses Cash payments for operating supplies + Decrease in accrued expenses - Increase in accrued expenses or + Increase in prepaids - Decrease in prepaids or

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Direct Method: Cash Payments 2 Cash Payments for Interest: Change in interest payable must be added to or deducted from interest expense to determine amount paid Change in interest payable must be added to or deducted from interest expense to determine amount paid Cash Payments for Income Tax: Change in income tax payable must be added to/deducted from income tax expense to determine amount paid Change in income tax payable must be added to/deducted from income tax expense to determine amount paid = Cash payments for interest = Cash payments for income tax Interest expense + Decrease in interest payable - Increase in interest payable or Tax expense + Decrease in income tax payable - Increase in income tax payable or

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 1: Operating Activities Direct Method Summary After all revenues and expenses have been adjusted to a cash basis, the operating activities section can be completed: After all revenues and expenses have been adjusted to a cash basis, the operating activities section can be completed:

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 2: Investing Activities Analyze changes in long-term asset and investment accounts Analyze changes in long-term asset and investment accounts Review transactions in these accounts to determine the effect on cash; exclude noncash transactionsReview transactions in these accounts to determine the effect on cash; exclude noncash transactions Cash purchases of long-lived assetsCash purchases of long-lived assets Cash proceeds from disposals of long-lived assetsCash proceeds from disposals of long-lived assets Changes in investment accounts that indicate purchase and sales of investmentsChanges in investment accounts that indicate purchase and sales of investments Note exceptions (Also must analyze short-term investments or notes receivable from non-trade transactions) Note exceptions (Also must analyze short-term investments or notes receivable from non-trade transactions)

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 3: Financing Activities Analyze changes in long-term liability and equity accounts Analyze changes in long-term liability and equity accounts Review transactions in these accounts to determine the effect on cashReview transactions in these accounts to determine the effect on cash Exclude noncash transactionsExclude noncash transactions Note exceptions (nontrade short-term notes payable)Note exceptions (nontrade short-term notes payable) Bonds payable: issue and redemptionBonds payable: issue and redemption Share capital: issue and reacquisition of sharesShare capital: issue and reacquisition of shares Retained earnings: dividends paidRetained earnings: dividends paid

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 4: The Cash Flow Statement Indirect Method Operating activities provided $172,000 of cash Investing activities used $141,000 of cash Financing activities used $9,000 of cash Significant noncash activity for $110,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Step 4: The Cash Flow Statement Direct Method Operating activities provided $172,000 of cash Investing activities used $141,000 of cash Financing activities used $9,000 of cash Significant noncash activity for $110,000

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Using the Information in the Financial Statements Cash flow statement gives information about financial health not found in other statements Cash flow statement gives information about financial health not found in other statements Shows the generation of cash and how it is being usedShows the generation of cash and how it is being used Shows whether a company is having difficulties with cash flow (liquidity)Shows whether a company is having difficulties with cash flow (liquidity) All financial statements must be read together in order to assess the overall financial health of a company All financial statements must be read together in order to assess the overall financial health of a company

Weygandt, Kieso, Kimmel, Trenholm, Kinnear Accounting Principles, Fifth Canadian Edition © 2010 John Wiley & Sons Canada, Ltd. Free Cash Flow Describes the cash remaining from operating activities after cash outlays for non-expansionary capital expenditures Describes the cash remaining from operating activities after cash outlays for non-expansionary capital expenditures Not readily available, so net cash from investing activities is substitutedNot readily available, so net cash from investing activities is substituted Shows how much cash is available to expand, repay debt or pay dividends Shows how much cash is available to expand, repay debt or pay dividends - = Cash Used (Provided) by Investing Activities Cash Provided (Used) by Operating Activities Free Cash Flow

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