12 Introduction to Financial Accounting Information, 7/e The Statement of Cash Flows Statements and the Annual Report 12 PowerPoint Author: Catherine Lumbattis COPYRIGHT © 2011 South-Western/Cengage Learning

Purpose of the Statement of Cash Flows Explains changes in cash over a period of time Summarizes cash inflows and outflows from: Financing Activities Operating Activities Investing Activities LO1

Cash Equivalents Readily convertible to cash Examples: Little risk of price change Original maturity to investor of three months or less Examples: Commercial paper U.S. Treasury bills Certain money market funds LO2

Statement of Cash Flows Format outflows Cash inflows Classified by: Operating activities Investing activities Financing activities = + Beginning Cash and Cash Equivalents = Ending Cash and Cash Equivalents Increase or decrease in cash and cash equivalents LO3

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 Collection of customer accounts Cash transactions concerned with acquiring and selling products and services Payment to suppliers for inventory Payment of wages Payment of taxes

Investing Activities Cash transactions concerned with acquiring and disposing of long-term assets Capital expenditures Purchase/sale of another company Sale of property, plant and equipment

Financing Activities Issuance/repayment of bank note Issuance/repurchase of stock Cash transactions concerned with the raising and repayment of funds in the form of debt and equity Issuance/retirement of bonds Payment of dividends

Categorizing Cash Flow Activities Current assets and current liabilities Operating Activities Long-term assets Investing Activities Long-term liabilities or stockholders’ equity Financing Activities

Noncash Investing and Financing Activities Disclose important financing and investing activities which do not require cash Exchange stock for assets Buy assets through debt financing from supplier

Methods to Report Cash from Operating Activities Direct Method Reports major classes of gross cash receipts and cash payments The amount of cash provided by operating activities is the same under both methods Indirect Method Adjusts net income to remove the effect of all accruals and deferrals LO4

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: Outflows (xxx) 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)

Preparing the Statement Cash Flows: Direct Method Step 1: Set up 3 schedules with the following headings: Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Step 2: Determine the cash flows from operating activities Step 3: Determine the cash flows from investing activities Step 4: Determine the cash flows from financing activities LO5

Direct Method Operating Activities Consider each of the items on the Income Statement and any related current assets or liabilities from the Balance Sheet: Accounts Receivable, January 1 $ 57,000 + Sales revenue 670,000 Cash collections ( ?????) = Accounts Receivable, Dec 31 $ 63,000 - Cash collections ????? From Balance Sheet

Direct Method Operating Activities Accounts Receivable, Jan. 1 $ 57,000 + Sales on account 670,000 - Accounts Receivable, Dec 31 ( 63,000) Cash collections $664,000

Direct Method Operating Activities Inventory, Jan. 1 $ 92,000 - Inventory, Dec. 31 84,000 From Balance Sheet = Cost of goods sold $ 390,000 + Purchases on account ????

Direct Method Operating Activities Inventory, Jan. 1 $ 92,000 - Cost of Goods Sold (390,000) - Inventory, Dec 31 (84,000) = Purchases on account $ 382,000

Direct Method Operating Activities Accounts Payable, Jan 1 $ 31,000 - Accounts Payable, Dec 31 38,000 + Purchases 382,000 = Cash payments for Purchases $ 375,000

There is no effect on cash flow from depreciation. Direct Method Operating Activities Review entries recorded during period: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenues - Expenses = Net Equity Income Accumulated Depreciation Depreciation Expense (40,000) (40,000) (40,000) (40,000) There is no effect on cash flow from depreciation.

Direct Method Operating Activities Prepaid Insurance, Jan 1 $18,000 From Balance Sheet + Cash payments ????? Insurance Expense (12,000) = Prepaid Insurance, Dec 31 $12,000

Direct Method Operating Activities Prepaid Insurance, Jan 1 $18,000 - Insurance Expense 12,000 - Prepaid Insurance, Dec 31 12,000 = Cash payments for Insurance $ 6,000

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

Preparing the Statement of Cash Flows: Direct Method Step 3: Determine the cash flows from investing activities

Direct Method Investing Activities From Balance Sheet LT Investments , Jan 1 $ 90,000 + LT Investments purchased for cash ????? LT Investments sold ( 0) = LT Investments, Dec 31 $120,000

Direct Method Investing Activities LT Investment, Jan 1 $ 90,000 - LT Investments sold 0 - LT Investments, Dec 31 120,000 = Cash payments for LT Investments $ 30,000

Direct Method Investing Activities Review entries recorded during period: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenues - Expenses = Net Equity Income Land = Notes Payable 50,000 50,000 No cash was involved in this transaction so it should be reported in a separate schedule instead of directly on the statement of cash flows.

Direct Method Investing Activities Property and Equipment , Jan 1 $280,000 + Property and Equipment purchased 75,000 From Balance Sheet - Property and Equipment sold ????? =Property and Equipment, Dec 31 $320,000

Direct Method Investing Activities Property and Equipment, Jan 1 $280,000 +Property and Equipment purchased 75,000 - Property and Equipment, Dec 31 (320,000) = Property and Equipment Sold $ 35,000

Direct Method Investing Activities Accumulated Depreciation , Jan 1 $ 75,000 + Depreciation Expense 40,000 From Balance Sheet - Accumulated Depreciation on assets sold ????? = Accumulated Depreciation, Dec 31 $100,000

Direct Method Investing Activities Accumulated Depreciation, Jan 1 $ 75,000 + Depreciation Expense 40,000 - Accumulated Depreciation, Dec 31 (100,000) = Accumulated Depreciation on Equipment Sold $ 15,000

Schedule of Cash Flows from Investing Activities Cash receipts from: Cash payments for: Sale of machine 25,000 30,000 Purchase of investments 75,000 Purchase of property and equipment Net Cash Outflows from Investing Activities $80,000

Preparing the Statement of Cash Flows: Direct Method Step 4: Determine the cash flows from financing activities

Direct Method – Financing Activities Review entries recorded during period: Balance Sheet Income Statement Assets = Liabilities + Stockholders’ Revenues - Expenses = Net Equity Income Land = Notes Payable 50,000 50,000 No cash was involved in this transaction so it should be reported in a separate schedule instead of directly on the statement of cash flows.

Direct Method Financing Activities Bonds Payable , Jan 1 $260,000 From Balance Sheet - Bonds Payable Retired ????? = Bonds Payable, Dec 31 $200,000

Direct Method Financing Activities Bonds Payable, Jan 1 $ 200,000 - Bonds Payable, Dec 31 (260,000) = Bonds Payable Retired $ 60,000

Direct Method Financing Activities Capital Stock , Jan 1 $ 75,000 From Balance Sheet + Capital Stock Sold ????? = Capital Stock , Dec 31 $100,000

Direct Method Financing Activities Capital Stock, Jan 1 $ 75,000 - Capital Stock, Dec 31 (100,000) = Capital Stock Sold $ 25,000

Direct Method Financing Activities Retained Earnings, Jan 1 $193,000 + Net income 120,000 From Balance Sheet - Cash Dividends ????? =Retained Earnings, Dec 31 $246,000

Direct Method Financing Activities Retained Earnings, Jan 1 $193,000 + Net income 120,000 - Retained Earnings, Dec 31 (246,000) = Cash Dividends $ 67,000

Schedule of Cash Flows from Financing Activities Cash receipts from: Cash payments for: 63,000 Retirement of bonds 67,000 Payment of cash dividends Issuance of stock 25,000 Net Cash Outflows from Financing Activities $105,000

Indirect Method Operating Activities Income Statement Conversion of accrual to cash basis Cash Flows from Operating Activities LO6

Indirect Method – Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease $6,000 Accounts Receivable Bal. Jan. 1 57,000 Bal. Dec. 31 63,000 + Net increase 6,000

Indirect Method Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase $8,000 Inventory Bal. Jan. 1 92,000 Bal. Dec. 31 84,000 - Net decrease 8,000

Indirect Method – Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Increase $7,000 Accounts Payable Bal. Jan. 1 $ 31,000 Bal. Dec. 31 $ 38,000 +Net increase 7,000

Salaries and Wages Payable Indirect Method Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Increase $2,000 Salaries and Wages Payable Bal. Jan. 1 $ 9,000 Bal. Dec. 31 $ 7,000 - Net decrease 2,000

Indirect Method Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Decrease $6,000 Prepaid Insurance Bal. Jan. 1 $18,000 Bal. Dec. 31 $12,000 - Net decrease 6,000

Indirect Method – Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 Increase $3,000 Income Taxes Payable Bal. Jan. 1 $5,000 Bal. Dec. 31 $8,000 +Net increase 3,000

Indirect Method Operating Activities Net cash flows from operating activities: Net income xx,xxx Adjustments to reconcile net income to net cash: Increase in accounts receivable (6,000) Decrease in inventory 8,000 Increase in accounts payable 7,000 Decrease in salaries and wages payable (2,000) Decrease in prepaid insurance 6,000 Increase in income taxes payable 3,000 Gain on sale of machine (5,000) Depreciation expense 40,000 Loss on retirement of bonds 3,000 Gain is not part of operating activities Add back noncash expense 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 and updated its existing base of long-term assets Cash Flow from Operating Activities – Capital Expenditures Average Amount of Debt Maturing over Next Five Years LO7

Accounting Tools: 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 LO8

Indirect Method: Using a Work Sheet Record investing and 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 and 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