The Statement of Cash Flows 21 hapter The Statement of Cash Flows 1 1 1 1

Objectives 1. Define operating, investing, and financing activities. 2. Know the categories of inflows and outflows of cash. 3. Classify cash flows as operating, investing, or financing. 4. Explain the direct and indirect methods for reporting operating cash flows. 5. Prepare a simple statement of cash flows. 2 2 2 4

Objectives 6. Use a worksheet for a statement of cash flows. 7. Compute and disclose interest paid and income taxes paid. 8. Identify the operating cash inflows and outflows under the direct method (Appendix). 9. Compute the operating cash flows under the direct method (Appendix).

Operating Activities Operating activities include all transactions and other events that are not investing and financing activities. Operating activities include transactions involving acquiring, selling, and delivering goods for sale, as well as providing services. Cash receipts from the sale of goods or services and collections of accounts receivable are typical cash inflows from operating activities. Cash payments to suppliers for inventory and on account, for wages, and for taxes are examples of cash outflows from operating activities.

Investing Activities Typical investing activities include transactions involving: Lending money and collecting on the loan. Acquiring and selling investments (both current and noncurrent). Acquiring and selling property, plant, and equipment.

Financing Activities Typical financing activities include transactions involving: Obtaining resources from owners. Distributing returns to owners. Obtaining resources from creditors. Repaying creditors.

Equation for Change in Cash Increases in Cash = Increases in Liabilities + Increases in Stockholders’ Equity + Decreases in Assets Other Than Cash This equation is based on the fundamental accounting equation: A = L + SE

Equation for Change in Cash And... Decreases in Cash = Decreases in Liabilities + Decreases in Stockholders’ Equity + Increases in Assets Other Than Cash

Inflows of Cash Decreases in assets other than cash. The sale or disposal of a noncash asset causes an inflow of cash. Increases in liabilities. The issuance or other incurrence of liabilities causes an inflow of cash. Increases in stockholders’ equity. Net income and additional investments by owners result in an inflow of cash.

Outflows of Cash Increase in assets other than cash. The acquisition of noncash assets causes an outflow of cash. Decreases in liabilities. The payment of liabilities causes an outflow of cash. Decreases in stockholders equity. The payment of dividends and the acquisition of treasury stock are two common transactions that result in an outflow of cash.

Operating Activities Decrease in Accounts Receivable Increase in Accounts Receivable + - or = Increase in Cash Inflows From Operating Activities Sales Revenues

Operating Activities Decrease in Accrued Payables and Increases in Inventory Increase in Accrued Payables and Decrease in Inventory + - or Expenses (including Cost of Goods Sold) = Increase in Cash Outflows For Operating Activities

Operating Activities Sales Revenue Accounts Receivable 30,000 42,000 Bal. 0 37,000 Smith Company made cash sales of $30,000 and credit sales of $42,000. During the year $37,000 was collected from creditors.

Operating Activities Sales Revenue Accounts Receivable 30,000 42,000 Bal. 72,000 Bal. 0 42,000 Bal. 5,000 37,000 Smith Company made cash sales of $30,000 and credit sales of $42,000. During the year $37,000 was collected from creditors.

Operating Activities Sales Revenue Accounts Receivable 30,000 42,000 Bal. 72,000 Bal. 0 Sales Revenue - Increase in Accounts Receivable = Increase in Cash Inflows from Operating Activities $72,000 - $5,000 = $67,000 42,000 Bal. 5,000 37,000

Operating Activities Salaries Expense Salaries Payable 13,000 1,000 Bal. 0 Smith Company paid salaries of $13,000 and recorded salaries payable of $1,000 during the year. At year-end, the Salaries Expense account has a debit balance of $14,000.

Operating Activities Salaries Expense Salaries Payable 13,000 1,000 Bal. 14,000 Bal. 0 1,000 Bal. 1,000 Smith Company paid salaries of $13,000 and recorded salaries payable of $1,000 during the year. At year-end, the Salaries Expense account has a debit balance of $14,000.

Operating Activities Salaries Expense Salaries Payable 13,000 1,000 Bal. 14,000 Bal. 0 Expense - Increase in Accrued (Salaries) Payable = Increase in Cash Outflows for Operating Activities $14,000 - $1,000 = $13,000 1,000 Bal. 1,000

Direct Method FASB Statement Number 95 allows a choice of the direct or indirect method to report cash flows from operations.

Direct Method Cash flows From Operating Activities: Cash Inflows: Cash received from customers $72,600 Cash inflows from operating activities $72,600 Cash Outflows: Cash paid to suppliers $(38,000) Cash paid to employees (12,200) Cash paid for income taxes (6,000) Cash outflows for operating activities (56,200) Net cash provided by operating activities $16,400 Decrease in accounts receivable ($2,600) + sales revenue ($70,000) Salaries expense - increase in salaries payable Amount paid in cash. Increase in inventory ($2,000) + decrease in accounts payable ($7,000) + cost of goods sold ($29,000).

Indirect Method Net Cash flows From Operating Activities: Net income $14,000 Adjustments for differences between income flows and cash flows for operating activities: Add: Depreciation expense 8,000 Decrease in accounts receivable 2,600 Increase in salaries payable 800 Less: Increase in inventory (2,000) Decrease in accounts payable (7,000) Net cash provided by operating activities $16,400 Added back since depreciation is not an outflow of cash. Same amount as the direct method

Steps in Visual Inspection Method Prepare the statement’s heading and list the three major sections. Calculate the net change in cash that occurred during the accounting period. Determine the net income and list it as the first item in the net cash flow from operating activities section. Calculate the increase or decrease in each balance sheet account (except cash). Continued

Steps in Visual Inspection Method Determine whether the increase or decrease in each balance sheet account (except cash) caused an inflow or outflow of cash and whether the cash flow was related to an operating, investing, or financing activity. If no cash flow occurred in Step 5, determine whether the increase or decrease in each balance sheet account (except cash) was the result of a noncash income statement item or a simultaneous investing and/or financing transaction. Continued

Steps in Visual Inspection Method Complete the various sections of the statement and check that the subtotals of the sections sum to the net change in cash and that the sum of the net change in cash and the beginning cash balance is equal to the ending cash balance reported on the balance sheet.

Simple Statement of Cash Flows LEYTON COMPANY Statement of Cash Flows For Year Ended December 31, 2001 The statement’s heading Continued

Simple Statement of Cash Flows Net Cash Flow From Operating Activities Net income $ 7,000 Adjustments for differences between income and cash flows from operating activities: Add: Depreciation expense 2,300 Increase in accounts payable 1,500 Less: Increase in accounts receivable (2,700) Net cash provided by operating activities $8,100 Cash Flows From Investing Activities Payment for purchase of building $(12,000) Proceeds from sale of land, at cost 3,000 Net cash used for investing activities (9,000) Continued

Simple Statement of Cash Flows Cash Flows From Financing Activities Proceeds from issuance of bonds $ 7,000 Payment of dividends (3,500) Net cash provided by financing activities 3,500 Net increase in Cash $2,600 Cash, January 1, 2001 4,000 Cash, December 31, 2001 $6,600 This amount should match the balance of the Cash account in the ledger.

Steps 1-3: Setting up the worksheet. Worksheet Method Steps 1-3: Setting up the worksheet. Step 1: Prepare the column headings on a worksheet. Then enter the account title Cash on the first line of the account titles column and list the beginning balance, ending balance, and the change in cash in the respective columns. Step 2: Enter the titles of all the remaining accounts from the balance sheets on the worksheet and list each beginning and ending account balance, and the change in the account balance directly below the cash information.

Worksheet Method Steps 1-3: Setting up the worksheet. Step 3: Directly below these accounts, add the following headings: A. Net Cash Flow From Operating Activities B. Cash Flows From Investing Activities C. Cash Flows From Financing Activities D. Investing and Financing Activities Not Affecting Cash Leave sufficient room below each heading. Continued

Steps 4: Completion of the worksheet. Worksheet Method Steps 4: Completion of the worksheet. Account for all the changes in the noncash accounts. Reconstruct the journal entries that caused the changes in the noncash accounts directly on the worksheet. Use these general rules: (A) Start with net income. (B) Account for the changes in the current assets (except cash) and current liability accounts. (C) Account for the changes in the noncurrent accounts. Continued

Worksheet Method Steps 5: Record the net change in cash. Make a final worksheet entry to record the net change in cash. The difference between the total cash inflows and outflows must be equal to the change in the Cash account. Steps 6: Prepare the formal statement. Prepare the statement of cash flows and the accompanying schedule from the information developed on the worksheet.

Worksheet Method Analyzing Complex Transactions During the year, an earthquake (extraordinary event) occurred that destroyed a building owned by the company with a cost of $10,000 and a book value of $5,200. The company received after-tax proceeds of $3,100 from its insurance company. First, let’s reconstruct the original entry.

Analyzing Complex Transactions Worksheet Method Analyzing Complex Transactions Now, we can analyze the entry to help us with recording it on the worksheet. Cash 3,100 Accumulated Depreciation: Buildings 4,800 Extraordinary loss 2,100 Buildings 10,000 Cash Flows From Investing Activities: Proceeds From Building Destroyed by Earthquake 3,100 Accumulated Depreciation: Buildings 4,800 Net Cash Flow From Operating Activ. 2,100 Buildings 10,000

Analyzing Complex Transactions Worksheet Method Analyzing Complex Transactions Let’s reconstruct both entries related to the bond issue and prepare them for the worksheet. On January 1 the company issued bonds payable with a face value of $10,000, receiving proceeds of $9,000. The company amortized $100 of the discount during the year.

Analyzing Complex Transactions Worksheet Method Analyzing Complex Transactions Cash 9,000 Discount on Bonds Payable 1,000 Bonds Payable, 10% 10,000 Cash Flows From Financing Activities: Proceeds From Issuance of Bonds 9,000 Discount on Bonds Payable 1,000 Bonds Payable, 10% 10,000 Continued

Analyzing Complex Transactions Worksheet Method Analyzing Complex Transactions Bond Discount Amortization 100 Discount on Bonds Payable 100 Cash Flows From Operating Activities: Bond Discount Amortization 100 Discount on Bonds Payable 100

Analyzing Complex Transactions Special Topics Analyzing Complex Transactions Here is another situation that was not part of the chapter’s comprehensive problem. A company sold equipment with a cost of $2,200 and accumulated depreciation of $700 for $2,100.

Special Topics Analyzing Complex Transactions Cash 2,100 Accumulated Depreciation 700 Equipment 2,200 Gain on Sale of Equipment 600 Cash Flows From Investing Activities: Proceeds From Sale of Equipment 2,100 Accumulated Depreciation 700 Equipment 2,200 Net Cash Flow From Operating Activities: Gain on Sale of Equip. 600 Make the worksheet entry in journal entry format.

Interest Paid and Income Taxes Paid FASB Statement Number 95 requires that a company using the indirect method also disclose its interest paid and income taxes paid.

Interest Paid and Income Taxes Paid Interest expense + Decrease in interest payable or - Increase in interest payable + Amortization of premium on bonds payable or - Amortization of discount on bonds payable = Interest paid

Interest Paid and Income Taxes Paid Income tax expense + Decrease in income taxes payable or - Increase in income taxes payable + Decrease in deferred tax liability or - Increase in deferred tax liability + Increase in deferred tax asset - Decrease in deferred tax asset = Income taxes paid Income Taxes Paid

Temporary and Long-Term Investments On November 28, 2000, Dougherty Company purchased 1,000 shares of Bear Company common stock for $40,000 as a temporary investment in available-for-sale securities. On December 31, 2000 the fair value of the stock was $42 per share. (1) Reconstruct the two entries related to this investment. (2) Make the worksheet entry in journal format.

Temporary and Long-Term Investments Temporary Investment in Available-for- Sale Securities 40,000 Cash 40,000 Temporary Investment in Available-for Sale Securities 40,000 Cash Flows From Investing Activities: Payment for Purchase of Temporary Investment 40,000 Continued

Temporary and Long-Term Investments Allowance for Change in Value of Investment 2,000 Unrealized Increase in Value of Available-for-Sale Securities 2,000 Allowance for Change in Value of Investment 2,000 Unrealized Increase in Value of Available-for-Sale Securities 2,000 No change! This entry appears only in the upper portion of the worksheet.

Temporary and Long-Term Investments On January 16, 2001 Dougherty Company sold its investment in Bear Company stock for $45,000. Cash 45,000 Temporary Investment in Available-for-Sale Securities 40,000 Gain on Sale of Temporary Invest. 5,000 Unrealized Increase in Value of Available-for-Sale Securities 2,000 Allowance for Change in Value of Investment 2,000

Temporary and Long-Term Investments Cash Flows From Investing Activities: Proceeds From Sale of Temporary Investment 45,000 Temporary Investment in Available-for-Sale Securities 40,000 Net Cash Flow From Operating Activities: Gain on Sale of Temporary Investment 5,000 The second entry is unchanged.

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