The Statement of Cash Flows Chapter 12 The Statement of Cash Flows Financial Accounting, Alternate 4e by Porter and Norton

Cash Flows and Net Income for Four Computer Companies in 2002 (in millions) Increase (Decrease) Net Income in Cash (Loss) $ 591 $2,122 (948) 3,579 6,995 (903) (265) (298) Dell Computer Corp. IBM Hewlitt-Packard Co. Gateway, Inc.

Purpose of the Statement of Cash Flows Explains changes in cash over a period of time Summarizes cash inflows and outflows from: Operating Activities Investing Activities Financing Activities

Cash Equivalents Readily convertible to cash Little risk of price change Original maturity to investor of three months or less 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 28 29 30 31 27 Examples: Commercial paper U.S. Treasury bills Certain money market funds

Statement of Cash Flows Format outflows Cash inflows Classified by: Operating activities Investing activities Financing activities = Beginning Cash + = Ending Cash Increase or decrease in cash

Statement of Cash Flows Format Cash flows from operating activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by operating activities $ xxx Cash flows from investing activities: Net cash provided (used) by investing activities xxx Cash flows from financing activities: Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $ xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $ xxx from balance sheets

Operating Activities Incur employee salaries and wages Cash transactions concerned with acquiring and selling products and services Sell products and services Incur utility and other operating costs Make inventory purchases

Purchase/Sell intangible assets (e.g., patents, trademarks) Investing Activities Purchase/Sell long-term investments Cash transactions concerned with acquiring and disposing of long-term assets Buy/Sell property, plant & equipment Purchase/Sell intangible assets (e.g., patents, trademarks)

Financing Activities Sell/Repurchase stocks Cash transactions concerned with internal and external financing of the business Borrow $/ repay loans Issue/Retire bonds Issue dividends Paycheck for Date Dept. of Treasurer Jane Doe

Categorizing Cash Flow Activities Income Statement Transactions Current Assets and Liabilities Operating Activities Long-Term Assets Investing Activities Long-Term Liabilities or Stockholders’ Equity Financing Activities

Methods to Report Cash from Operating Activities Direct Method Indirect Method both methods arrive at same cash from operating activities reports major classes of cash receipts and payments adjusts net income to remove effect of accruals and deferrals

Preparing the Statement of Cash Flows: Direct Method Step 1 Set up three schedules Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Step 2 Determine the cash flows from operating activities by analyzing each item on the income statement, current assets and current liabilities

Direct Method - Operating Activities Determine cash collected from customers: Beginning accounts receivable $ 57,000 + Sales revenue 670,000 – Cash collections (x) = Ending accounts receivable $ 63,000 From Balance Sheet From Income Statement Solve for x. Cash collections = $664,000

Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000

Direct Method - Operating Activities Interest Revenue: Since no Interest Receivable account exists on the balance sheet, the interest earned was received, not accrued. Gain on Sale of Machine: Not an operating cash flow

Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000

Direct Method - Operating Activities Calculate cash paid to suppliers by first finding purchases: Beginning inventory $ 92,000 + Purchases (x) – Cost of goods sold (390,000) = Ending inventory $ 84,000 Solve for x. Purchases = $382,000

Direct Method - Operating Activities Then examine Accounts Payable to determine cash paid to suppliers: Beginning accounts payable $ 31,000 + Purchases 382,000 – Cash payments (x) = Ending accounts payable $ 38,000 Solve for x. Cash paid to suppliers = $ 375,000

Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000 Cash payments for: Inventory purchases (375,000)

Direct Method - Operating Activities Salaries and wages: Beginning salaries & wages pay. $ 9,000 + Salaries & wages expense 60,000 – Cash payments to employees (x) = Ending salaries & wages pay. $ 7,000 Solve for x. Cash paid for salaries & wages = $ 62,000

Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000 Cash payments for: Inventory purchases (375,000) Salaries and wages (62,000)

Direct Method - Operating Activities Depreciation expense is not a cash flow Insurance Expense and Prepaid Insurance: Beginning prepaid insurance $ 18,000 + Cash payments for insurance (x) – Insurance expense (12,000) = Ending prepaid insurance $ 12,000 Solve for x. Cash paid for insurance = $6,000

Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account 664,000 Interest 15,000 Cash payments for: Inventory purchases (375,000) Salaries and wages (62,000) Insurance (6,000)

Direct Method - Operating Activities Interest Expense: Since no Interest Payable account exists on the balance sheet, the interest expensed was paid, not deferred. Income Tax Expense and Income Taxes Payable: Beginning income taxes payable $ 5,000 + Income tax expense 50,000 – Cash payments for taxes (x) = Ending income taxes payable $ 8,000 Solve for x. Cash paid for taxes = $47,000

Schedule of Cash Flows from Operating Activities Cash receipts from: Sales on account $ 664,000 Interest 15,000 Cash payments for: Inventory purchases (375,000) Salaries and wages (62,000) Insurance (6,000) Interest (15,000) Taxes (47,000) Net cash provided by operating activities $ 174,000

Preparing the Statement of Cash Flows: Direct Method Step 3 Determine the cash flows from investing activities by examining the long-term asset accounts and any additional info

Direct Method – Investing Activities Long-Term Investments: The net increase of $30,000 matches the additional info given on the balance sheet and required the use of cash. Land: The additional balance sheet info reveals that a note payable was issued. No cash was involved in the land transaction so it should be reported in a separate schedule instead of on the Statement of Cash Flows

Direct Method – Investing Activities Property and Equipment: The additional balance sheet info reveals that equipment was purchased for $75,000 and a machine was sold for $25,000. Beginning property and equip. $280,000 + Acquisitions 75,000 – Disposals (x) = Ending property and equip. $320,000 Solve for x. The cost of fixed assets sold = $35,000

Direct Method – Investing Activities Accumulated Depreciation: Beginning accum. depreciation $ 75,000 + Depreciation expense 40,000 – Accum. depreciation on assets sold (x) = Ending accum. depreciation $100,000 Solve for x. The accumulated depreciation on the assets disposed of during the year = $15,000

Cash Flows from Investing Activities Schedule of Cash Flows from Investing Activities Cash inflows from: Sale of machine $ 25,000 Cash outflows from: Purchase of investment (30,000) Purchase of property and equip. (75,000) Net cash used by investing activities $(80,000)

Preparing the Statement of Cash Flows: Direct Method Step 4 Determine the cash flows from financing activities Paycheck for Date Dept. of Treasurer Jane Doe

Direct Method – Financing Activities Notes payable: This increase is already shown on a supplemental schedule of noncash activities. Bonds payable: Bonds with a face value of $60,000 are retired by paying $63,000.

Direct Method – Financing Activities Capital stock was issued for cash Retained earnings: Beginning retained earnings $ 193,000 + Net income 120,000 – Cash dividends (x) = Ending retained earnings $ 246,000 Solve for x. Cash paid for dividends = $67,000

Cash Flows from Financing Activities Schedule of Cash Flows from Financing Activities Cash inflows from: Issuance of stock $ 25,000 Cash outflows from: Retirement of bonds (63,000) Payment of cash dividends (67,000) Net cash used by financing activities $(105,000)

Noncash Investing and Financing Activities Disclose important financing and investing activities which do not require cash Exchange Stock for Assets Certificate of Stock Examples: Buy Assets through Debt Financing from Supplier

Statement of Cash Flows Format Cash flows from operating activities: Inflows $ xxx Outflows (xxx) Net cash provided (used) by operating activities $ xxx Cash flows from investing activities: Net cash provided (used) by investing activities xxx Cash flows from financing activities: Net cash provided (used) by financing activities xxx Net increase (decrease) in cash and cash equivalents $ xxx Cash and cash equivalents at beginning of year xxx Cash and cash equivalents at end of year $ xxx Only section of statement that differs in form between direct and indirect method (net cash flow total is the same)

Indirect Method - Operating Activities Income Statement Conversion of accrual to cash basis Cash Flows from Operating Activities

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable (6,000) From balance sheet: Accts. receivable, 2004 $63,000 Accts. receivable, 2003 57,000 $ 6,000 Decrease $6,000

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable (6,000) Gain on sale of machine 5,000 Selling price of machine $25,000 Book value of machine 20,000 Gain on sale $ 5,000 Increase $5,000

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 From balance sheet: Inventory, 2003 $92,000 Inventory, 2004 84,000 $ 8,000 Decrease $8,000

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 From balance sheet: Accts. payable, 2004 $38,000 Accts. payable, 2003 31,000 $ 7,000 Increase $7,000

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Salaries & wages payable, 2003 $9,000 Salaries & wages payable, 2004 7,000 $2,000 Decrease $2,000

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Prepaid insurance, 2003 $18,000 Prepaid insurance, 2004 12,000 $ 6,000 Decrease $6,000

Indirect Method - Operating Activities Add back noncash expense Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Depreciation expense 40,000 Add back noncash expense

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine 5,000 Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Depreciation expense 40,000 Increase in income taxes payable 3,000 Inc. taxes payable, 2004 $8,000 Inc. taxes payable, 2003 5,000 $3,000 Increase $3,000

Indirect Method - Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income: Increase in accounts receivable ( 6,000) Gain on sale of machine ( 5,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries & wages payable ( 2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 Depreciation expense 40,000 Loss on retirement of bonds 3,000 Report entire outflow as a financing activity

Cash Flow Adequacy Measures company’s ability to meet principal and interest obligations Creditors concerned with cash available to repay debts after company has replaced its long-term assets Cash Flow from Operating Activities - Capital Expenditures . Avg. Debt Maturing over Next Five Years

A Work-Sheet Approach to the Statement of Cash Flows Appendix Accounting Tools: A Work-Sheet Approach to the Statement of Cash Flows

Indirect Method: Using a Work Sheet Enter account balances

Indirect Method: Using a Work Sheet Record investing & financing activities

Indirect Method: Using a Work Sheet Enter net income

Indirect Method: Using a Work Sheet Enter noncash revenues or expenses

Indirect Method: Using a Work Sheet Extend current assets & current liabilities

Indirect Method: Using a Work Sheet Total columns

Indirect Method: Using a Work Sheet Determine net cash inflow (outflow)

End of Chapter 12