Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.) Intermediate Accounting, 10th Edition Kieso , Weygandt , and Warfield Chapter 24: The Statement of Cash Flows Prepared by Krishnan Ranganathan , Angelo State University, San Angelo, Texas 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Usefulness of the Statement of Cash Flows The information may help users assess the following aspects: The entity’s ability to generate future cash flows The entity’s ability to pay dividends and meet obligations The reasons as to why net income and net cash flow from operating activities differ Cash and non cash investing and financing activities during the year 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

The Cash Flow Statement The cash flow statement provides information about: the cash receipts (cash inflows), and uses of cash (cash outflows) during the year Inflows and outflows are reported for: operating activities, investing activities, and financing activities during the year. 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Statement of Cash Flows: Concept Operating activities Investing Financing inflows Cash Pool Operating activities Investing Financing outflows 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Preparing a Statement of Cash Flows There are TWO methods of preparing the statement of cash flows: the indirect method and the direct method The indirect method (discussed in Chapter 5) derives cash flows from accrual basis statements. The direct method determines cash flows directly for each source or use of cash 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Statement of Cash Flows: Indirect Method - Concept Earned Revenues Eliminate noncash revenues Net Income + - Operating cash flow Eliminate noncash charges Expenses Incurred 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

The Statement of Cash Flows: Indirect method Accrual Basis Statements Cash Flow Statement Income Statement items & Changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals and non cash charges to get cash flows Balance Sheet: Changes in Non-Current Assets Investing activities: Inflows from sale of assets and Outflows from purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities: Inflows and outflows from loan and equity transactions 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Direct Method (Operating Activities) Inflows Outflows From sales of goods or services From returns on loans (interest) and returns on equity securities (dividends) To suppliers for inventory To employees for services To government for taxes To lenders for interest To others for expenses 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Investing and Financing Activities For the direct and indirect methods: the sections reporting investing and financing activities are the same The net inflows or outflows for each section (under the two methods) are identical The operating activities are reported differently, however. 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Format of the Statement of Cash Flows: Indirect Method Cash flows from operating activities: Net Income $ XXX Adjustments (to arrive at cash flow from operations) $ XX (List of individual inflows and outflows) Net cash flow from operating activities $ XXX Cash flows from investing activities: (List of individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Cash flows from financing activities: (List of individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Format of the Statement of Cash Flows: Direct Method Cash flows from operating activities: Cash receipts (individually): Inflows $ XXX Cash payments to suppliers (separately): outflows ($ XXX) Net cash flow from operating activities $ XXX Cash flows from investing activities: (List of individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Cash flows from financing activities: (List of individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Indirect Method: Example Intelmarkets begins operations on 1.1.2000. The income statement and balance sheet for year 2000 are as follows: Income Statement Revenues: $ 200,000 Less: Cost of goods sold ($ 110,000) Gross Margin $ 90,000 Less: Operating expenses ($ 40,000) Net Income before Tax: $ 50,000 less: Income Tax ($ 15,000) Net Income after Tax $ 35,000 Operating expenses do not contain any non-cash charges 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Indirect Method: Example Balance Sheet Dec 31, 2000 Jan 1, 2000 Assets: Cash $ 25,000 $-0- Accounts Receivable $ 32,000 $-0- Inventory $ 29,000 $-0- Land $110,000 $-0- Total $196,000 $-0- Liabilities and Equity: Accounts Payable $ 24,000 $-0- Common Stock $147,000 $-0- Retained Earnings $ 25,000 $-0- Total $196,000 $-0- 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Operations: Net Outflow 2,000 Operating Activities Net Income after Tax $35,000 Accounts Receivable +$ 32,000 Inventory +$ 29,000 Accounts Payable +$ 24,000 Accrual Basis Net Income after Tax $35,000 Less: Increase in A/Rec ($ 32,000) Less: Increase in Inventory($ 29,000) Add: Increase in Accounts Payable $ 24,000 Cash Flow Changes between beginning and ending balances Operations: Net Outflow 2,000 See explanations next slide 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.) Operating Activities A/Rec increased by $32,000 Cash collections are less than revenue recognized Reduce net income by $32,000 to derive cash flows from operations 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.) Operating Activities Inventory increased by $29,000 Cost of goods sold for the year decreases by $29,000. Reduce net income by $29,000 to derive cash flows from operations Net income for the year increases by $29,000 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Investing and Financing Activities Land + $110,000 Accrual Basis Investing Activities: Purchase of Land: ($110,000) Outflow ($110,000) Cash Flow Financing Activities: Issue of Common Stock: $147,000 Dividends paid: ($10,000) Inflow $137,000 Common Stock +$147,000 Retained Earnings +$ 25,000 Beg Bal: $0 Net Income: $35,000 less: Dividends ($10,000) End Balance: $25,000 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Cash Flow Statement: (Indirect Method) - Summary Cash used by operating activities:($ 2,000) Cash used by investing activities:($110,000) Cash from financing activities: $137,000 Net inflow for the year $ 25,000 Beginning cash balance: $ -0- Ending cash balance $ 25,000 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Special Items: Depreciation Given: 2002 2001 Property, plant, and equipment $277,000 $247,000 Accumulated depreciation (178,000) (167,000) Other information: Depreciation expense $ 33,000 Gain on sale of equipment $ 14,500 During 2002, equipment costing $45,000 was sold for cash Present relevant T- accounts and cash flow information 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Special Items: Depreciation - Steps Prepare the T-Account for accumulated depreciation and determine the accumulated depreciation on asset sold Determine the cash flow from sale of equipment Determine any purchases of plant and equipment (at cost) Identify the inflows and outflows affecting the operating and investing sections 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Special Items: Depreciation Accu depr(beg) : $167,000 Plus: depreciation expense $ 33,000 less: depreciation on equip sold (?) $ 22,000 Accu. Depr (ending): $178,000 Accumulated Depreciation 1 Equipment sold (cost): $45,000 less: Accu depr on equipment $22,000 Book value of equipment sold $23,000 Add: Gain on sale $14,500 Cash from sale of equipment $37,500 Equipment Sold 2 Operating Activities: Depreciation - Inflow $33,000 Gain on sale ($14,500) Investing Activities: Sale of equipment - inflow $37,500 Asset purchases - outflow ($75,000) Cash Flow Statement 4 Beginning balance: $247,000 Add: Purchases (?) $ 75,000 Less: Equipment Sold $ 45,000 Ending balance: $277,000 Prop, Plant, & Equipment 3 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Indirect Method: Special Items - Summary Note the following adjustments to net income in deriving operating cash flow: Loss on sale of assets is added to net income Gain on sale of assets is deducted from net income Discount on bonds payable (as amortized) is added to net income Premium on bonds payable (as amortized) is deducted from net income 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Cash Flow Statement: Direct Method - Example Refer to the data for the Indirect method. Note that the presentation of the Operating Activities under the direct method is different Note also that the net outflow for operating activities is the same under both methods Cash flows for Investing and Financing activities are identical under both methods. 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Direct Method: Concept Cash Receipts From sale of goods and services to customers From receipts of interest and dividends Cash Payments To suppliers To employees For operating exp For interest For taxes Cash flow from opera- tions less equals 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Cash Flow Statement: Direct Method Cash receipts from customers: = Revenue from credit sales + Decrease in A/Rec balances - Increase in A/Rec balances = $200,000 - $32,000 = $168,000 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Cash Flow Statement: Direct Method Cash payments to suppliers: = cost of goods sold + increase in inventory - decrease in inventory + decrease in accounts payable - increase in accounts payable = $110,000 + $29,000 - $24,000 = $115,000 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Cash Flow Statement: Direct Method Cash payments for operating and other expenses: = Operating expenses + increase in prepaid expenses - decrease in prepaid expenses + decrease in accrued expenses payable - increase in accrued expenses payable $40,000 operating + $15,000 tax = $55,000 Note: There are no accruals in the balance sheet for these accounts. So, these are deemed cash payments. 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Direct method: Operating Activities Cash receipts from sales $ 168,000 Cash paid to suppliers for merchandise ($ 115,000) Cash paid for income taxes ($ 55,000) Net cash outflow ($ 2,000) 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Reporting Significant Non Cash Transactions Transactions, not involving cash inflows or cash outflows, are non cash transactions They are not reported in the body of the cash flow statement If material, they are reported as notes to the statement or in a supplementary schedule to the financial statements Example is: issue of bonds (payable) for purchase of land 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)

Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.) COPYRIGHT Copyright © 2001 John Wiley & Sons, Inc. All rights reserved. Reproduction or translation of this work beyond that permitted in Section 117 of the 1976 United States Copyright Act without the express written permission of the copyright owner is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons, Inc. The purchaser may make back-up copies for his/her own use only and not for distribution or resale. The Publisher assumes no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein. 11/13/2018 Intermediate Accounting, 10t edition, Chapter 24 (Kieso et al.)