Chapter 13 The Statement of Cash Flows ©2013 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part.

Introduction The statement of cash flows reports the impact of a firm’s operating, investing, and financing activities on cash flows during the accounting period. In fact, users of financial statements have made the statement of cash flows one of the most important of the four required financial statements. 2

The Purpose of the Statement of Cash Flows * Provides information about cash inflows and outflows during a period. * Provides information about cash changes between two balance sheet dates. * Discloses items that affect the balance sheet but don’t show up in the income statement. * Categorizes changes as operating, investing, or financing activities.

Summary of Activities Making Up a Cash Flow Statement

Definition of Cash What is Cash? Accounting standards define certain items as equivalent to cash, which are combined with cash on the balance sheet and the statement of cash flows. A cash equivalent is an item that can be readily converted to a known amount of cash and has an original maturity to the investor of three months or less. Commercial paper, money market funds, and Treasury bills are examples of cash equivalents.

Example: The exchange of a Long-term Note Payable for Land Noncash Transactions Organizations may have exchange transactions that do not directly involve cash inflows or outflows, but still warrant disclosure on a statement of cash flows. These are primarily in the financing and investing areas. Example: The exchange of a Long-term Note Payable for Land

Separate Noncash Schedule Example Generally accepted accounting principles require that any significant noncash transaction be reported either in a separate schedule or in a footnote to the financial statements. ABC Inc. Statement of Cash Flows for Fiscal Year Ended 12/31/11 Net Income (amounts in thousands of dollars) $212,075 Adjustments to reconcile net earnings to net cash: Hhhhhhhhhhhhhhhhhhhhhhhhh hhhhhh Change in cash 217,266 Cash, January 1, 2011 725,002 Cash, December 31, 2011 $942,268 7

Direct and Indirect Method Differences for Cash Flows From Operations The direct method reports major classes of gross cash receipts and payments. The indirect method, starts with net income and removes the effect of all noncash items resulting from accruals or noncash expenses.

Which Method Should You Use? Direct Method: More straightforward and is useful for evaluating operating efficiency. Indirect Method: Focuses attention cash VS. accrual basis of accounting and must be prepared even if you use the Direct Method. Most Companies use the Indirect Method.

Changes in Cash Explained We begin with the Accounting Equation to further understand the changes in the Statement of Cash Flows: Assets = Liabilities + Owners’ equity Expanded: Cash + Noncash + Long-term = Current + Long-term + Capital + Retained Current Assets Liabilities Liabilities Stock Earnings Assets Rearranged: Cash = Current + Long-term + Capital + Retained – Noncash – Long-term Liabilities Liabilities Stock Earnings Current Assets Assets 10

Examples

Six Steps in Preparing the Statement of Cash Flows Compute net change in cash Six Steps in Preparing the Statement of Cash Flows Compute net cash provided by operating activities Compute net cash provided by investing activities Compute net cash provided by financing activities Compute net cash flow : Add the three activities sections Report significant noncash activities

Direct Method - Operating Cash Flows Operating activities that generate cash outflows include buying merchandise for resale to customers, making payments to employees, and making payments for other operating expenses, such as insurance, interest, rent, and taxes. Now let’s look at a modification of the cash expenditures for operating expenses formula to understand how cash outflows for purchases and payroll is computed.

Direct Method - Operating Cash Flows Cost of Goods Purchased Cost of Goods Sold ( ) = - Beginning – Ending Inventory Inventory Cash outflows for purchases Cost of Goods Purchased ( ) + = Beg. Accts – End. Accts Payable Payable Cash outflows for payroll ( ) Payroll Expense = + Beg. Payroll – End. Payroll Payable Payable 14

Indirect Method – Operating Cash Flows Net Income + Increases in related liabilities Decreases in related noncash assets - Increases in related noncash assets Decreases in related liabilities = Cash flow from operating activities

Examples of Additions and Deductions

Statement of Cash Flows for Fiscal Year Ended 12/31/10 Regardless of whether you use the Direct or Indirect method, both the investing and financing activities sections are calculated the same way. Only the Operating Section differs. ABC, Inc. Statement of Cash Flows for Fiscal Year Ended 12/31/10 hhhhhhhhhhhhhhhhhhhhhhhhh hhhhhh Cash flow from operating activities $496,624 Cash flow from investing activities $(120,671) Cash flow from financing activities $(158,641) Change in cash 217,266 Cash, January 1, 2010 725,002 Cash, December 31, 2010 $942,268 Supplemental Information: Interest paid $33,265 Income taxes paid 32,962

End of Chapter 13