C 22 The Statement of Cash Flows hapter Intermediate Accounting 10th edition Nikolai Bazley Jones An electronic presentation by Norman Sunderman Angelo State University COPYRIGHT © 2007 Thomson South-Western, a part of The Thomson Corporation. Thomson, the Star logo, and South-Western are trademarks used herein under license. 1 1 1 1

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

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

Purpose of a Cash Flow Statement Helps users assess A firm’s ability to generate positive cash flows from operating activities. A firm’s ability to meet its obligations and pay dividends. The reasons for the difference between net income and net cash flows. The effect of investing and financing on a firm’s financial position. Both the cash and noncash investing and financing transactions during the period.

Operating Activities Operating activities include transactions involving acquiring, selling, and delivering goods for sale, as well as providing services. Operating activities include all transactions and other events that are not investing and financing activities. 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 Investing activities include transactions involving noncurrent assets and short-term investments. Outflows (3) Inflows (3) Lending money and collecting principal on the loans. Acquiring and selling investments (both current and noncurrent). Acquiring and selling property, plant, and equipment.

Financing Activities Financing activities include transactions involving liabilities & equity: Inflows (2) Issuing stock for cash (new issue or treasury stock) Borrowing money (bonds and notes) Outflows (3) Paying cash dividends Repayments of amounts borrowed Purchase of treasury stock

Cash and Cash Equivalents The cash flow statement is prepared using cash and cash equivalents. Cash equivalents Within 3 months of maturity when purchased No risk--treasury bonds, treasury notes, treasury bills, money market, commercial paper Known amount of cash Purchases of cash equivalents are not reported

Indirect and Direct Methods FASB No. 95 allows two ways for a company to calculate and report its net cash flow from operating activities on its statement of cash flows.

Indirect and Direct Methods Even though the FASB recommends the direct method, more than 98% of companies use the indirect method. The first is called the direct method and the second is the indirect method.

Indirect Method Example

Steps in Visual Inspection Method-Indirect Method Prepare the statement’s heading and list the three major sections. Determine the net income and list it as the first item in the net cash flow from operating activities section. Add back any non-cash expenses. Adjust net income for gains and losses not related to operations. Continued

Steps in Visual Inspection Method-Indirect Method Adjust net income for the change in deferred taxes Adjust net income for income and losses on investments carried under the equity method. Continued

Steps in Visual Inspection Method-Indirect Method Examine all working capital accounts, except cash, short-term non-trade notes payable and dividends payable. A Debit to a noncash account is a Decrease in cash. (If the account had net debits during the year). A Credit to a noncash account is an increase in cash. (if the account had net credits during the year). Continued

Steps in Visual Inspection Method-Indirect Method Calculate the cash provided or cash used by operating activities. Examine comparative balance sheets for changes in non-current assets. Calculate the cash provided or cash used by investing activities. Examine long-term liabilities and equity accounts. Continued

Steps in Visual Inspection Method-Indirect Method Calculate the cash provided or cash used by financing activities. Calculate the net change in cash that occurred during the accounting period. Add the beginning cash The total should equal the ending cash on the balance sheet List interest and taxes paid. List significant noncash investing and financing activities.

Simple Statement of Cash Flows RYAN COMPANY Statement of Cash Flows For Year Ended December 31, 2007 The statement’s heading

Adjustments to Net Income Remember the adjustments to net income are: Noncash expenses Gains/losses on investments Deferred taxes Equity income Working capital changes

Indirect Method- Ryan Corporation Added back since depreciation is not an outflow of cash. 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 Credits to noncash accounts Debits to noncash accounts Same number as direct method

Leyton Company Information Page 1140 Leyton Company Information

Simple Statement of Cash Flows-Leyton Company 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) 1,100 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 Net cash provided by operating activities $8,100 Net cash used for investing activities (9,000) 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, 2007 4,000 Cash, December 31, 2007 $6,600 This amount should match the balance of the Cash account in the ledger.

Sale of Equipment Gains and losses from investing activities should be eliminated from operating activities by adding losses and deducting gains from net income. Dack Company sold equipment with a cost of $2,200 and accumulated depreciation of $700 for $2,100.

Deduct $600 from net income to reconcile net income to operating cash. Sale of Equipment Historical cost 2,200 Less: Accumulated depreciation 700 Book value $1,500 Gain (not operating) ? Cash proceeds $2,100 Deduct $600 from net income to reconcile net income to operating cash.

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 = $1,000 Interest Expense Interest Payable Bal. 0 1,100 Cash Paid 500 $100 discount amortization will not require cash 1,000 Bal. 500 Jones Company had $1,100 of interest expense, including $100 amortization of bond discount. The beginning balance in Interest Payable was $0 and the ending balance was $500. How much cash was paid for interest?

Taxes Payable/Deferred Taxes Taxes Paid Taxes Payable and Deferred Taxes can be combined to find taxes paid. Taxes Payable/Deferred Taxes = $7,050 Cash Paid 2,820 1,500 Bal.--Taxes Payable 1,920 Bal.--Deferred Taxes 2,130 Bal.--Taxes Payable 2,100 Bal.--Deferred Taxes 3,630 Taxes Expense = $7,050 The beginning and ending balances in Taxes Payable were $1,500 and $2,130 and the beginning and ending balances in Deferred Taxes were $1,920 and $2,100. Tax Expense was $3,630. How much cash was paid?

Direct Method Under the direct method, a company deducts its operating cash outflows from its operating cash inflows to determine its net cash flow from operating activities.

Direct Method Inflows (3) Cash from customers (A/R) Cash from interest revenue (Interest Receivable) Cash from dividend revenue (Dividends Rec.) Outflows (5) Cash paid to suppliers (A/P) Cash paid for wages (Wages Payable) Other cash expenses (Prepaid/Accrued) Cash paid for interest expense (Interest Payable) Cash paid for taxes (T/P and Deferred Tax)

Direct Method Use T accounts to examine the 3 inflows and 5 outflows in the direct method.

Cash From Customers Sales Revenue Accounts Receivable 30,000 42,000 Bal. 0 37,000 42,000 Bal. 5,000 Smith Company made cash sales of $30,000 and credit sales of $42,000. How much cash was collected from customers? $67,000

Dividends and Interest Collected Interest Receivable Dividends Receivable Bal. 30,000 Revenue 42,000 Bal. 12,000 Bal. 0 Revenue 4,000 Bal. 1,000 Ives Company earned interest revenue of $42,000 & dividend revenue of $4,000. Interest Receivable had a beginning balance of $30,000 and an ending balance of $12,000. Dividends receivable had a beginning balance of $0 and an ending balance of $1,000. How much cash from interest and dividends was collected?

Dividends and Interest Collected Interest Receivable =4,000 =72,000 Dividends Receivable Bal. 30,000 Revenue 42,000 Bal. 12,000 60,000 Bal. 0 Revenue 4,000 Bal. 1,000 3,000 =4,000 =72,000 Ives Company earned interest revenue of $42,000 and dividend revenue of $4,000. During the year $60,000 of interest and $3,000 of dividends was collected.

Cash Paid to Suppliers 62,000 Accounts Payable Inventory 62,000 $47,700 10,300 12,100 59,800 Bal. 12,500 Bal. 11,000 51,000 Cost of goods sold 49,500 Purchases 49,500 59,800 Copeland Company had beginning and ending balances in Accounts Payable of $10,300 and $12,100, respectively. The beginning and ending balances in inventory were $12,500 and $11,000 respectively. The cost of goods sold was $51,000. How much cash was paid to suppliers?

Prepaid/Accrued Expenses Cash Expenses Prepaid and accrued expenses can be combined to calculate the cash paid. Cash operating expenses exclude depreciation, amortization and depletion. Prepaid/Accrued Expenses =$372,000 Prepaid Bal. 20,000 Prepaid Bal. 12,000 60,000 Accrued Bal. 300,000 Cash operating expenses 32,000 Accrued Bal. =$372,000 Wolverine Company had beginning and ending balances in accrued expenses of $60,000 and $32,000, respectively. It had beginning and ending balances in prepaid expenses of $20,000 and $12,000, respectively. It had cash operating expenses of $300,000. How much cash was paid for expenses?

Prepaid/Accrued Expenses Wolverine Company paid $320,000 for expenses. Cash Expenses Prepaid/Accrued Expenses Prepaid Bal. 20,000 Cash paid 320,000 Prepaid Bal. 12,000 60,000 Accrued Bal. 300,000 Cash operating expenses 32,000 Accrued Bal. Wolverine Company paid $320,000 for expenses.

Cash Paid to Employees Salaries Payable Cash paid 13,000 0 Bal. 14,000 Salaries expense 1,000 Bal. Smith Company had beginning and balances in Salaries Payable of $0 and $1,000. respectively. Salary expense for the year was $14,000. How much cash was paid to employees?

Ryan Corporation’s Income Statement Direct Method Ryan Corporation’s Income Statement Sales revenue (cash and A/R) $70,000 Less: Cost of goods sold (cash and A/P) $(29,000) Salaries expense (cash and S/P) (13,000) Depreciation expense (8,000) (50,000 ) Income before income taxes $20,000 Income tax expense (cash) (6,000 ) Net income $14,000

Cash From Customers- Ryan Company Sales Revenue Accounts Receivable 70,000 Bal. 22,600 72,600 70,000 Bal. 20,000 Accounts receivable decreased by $2,600 for Ryan Company. How much cash was collected from customers? $72,600

Direct Method Remember to check for these cash flows. Inflows (3) Cash from customers (A/R) Cash from interest revenue (Interest Receivable) Cash from dividend revenue (Dividends Rec.) Outflows (5) Cash paid to suppliers (A/P) Cash paid for wages (Wages Payable) Other cash expenses (Prepaid/Accrued) Cash paid for interest expense (Interest Payable) Cash paid for taxes (T/P and Deferred Tax)

Cash Paid to Suppliers- Ryan Company Accounts Payable Inventory Cash paid $38,000 10,300 3,300 Bal. 9,000 Bal. 11,000 29,000 Cost of goods sold 31,000 Purchases 31,000 Ryan Company had beginning and ending balances in Accounts Payable of $10,300 and $3,300, respectively. The beginning and ending balances in inventory were $9,000 and $11,000 respectively. The cost of goods sold was $29,000. How much cash was paid to suppliers?

Cash Paid to Employees- Ryan Company Ryan Company had beginning and balances in Salaries Payable of $200 and $1,000. respectively. Salary expense for the year was $13,000. How much cash was paid to employees? Salaries Payable Cash paid 12,200 200 Bal. 13,000 Salaries expense 1,000 Bal. Ryan Company had no change in the Taxes Payable and Deferred Taxes accounts.

Direct Method-Ryan Company 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

Reconciliation of Net Income to Cash Provided by Operations- Direct Method In other words, the indirect method is required even when using the direct method. When the direct method is used, a schedule to reconcile net income to cash provided by operations is required. Yes.

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.

Leave sufficient room below each heading. 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

Worksheet Method Step 4: Completion of the worksheet Continued 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 Step 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. Step 6: Prepare the final worksheet entry Prepare the statement of cash flows and the accompanying schedule from the information developed on the worksheet.

Worksheet

Worksheet

Analyzing Complex Transactions Worksheet Method Analyzing Complex Transactions First, let’s reconstruct the original entry. During the year the company sold land that cost $2,200 for $3,900.

Analyzing Complex Transactions Worksheet Method Analyzing Complex Transactions Now, we can analyze the entry to help us with recording it on the worksheet. Cash 3,900 Land 2,200 Gain on Sale of Land 1,700 Cash Flows From Investing Activities: Proceeds From Sale of Land 3,900 Land 2,200 Net Cash Flow From Operating Activities: Gain 1,700

Analyzing Complex Transactions 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. This is a tougher one.

Analyzing Complex Transactions Worksheet Method Analyzing Complex Transactions Cash 3,100 Accumulated Depreciation: Buildings 4,800 Extraordinary loss 2,100 Buildings 10,000 Now, we can reconstruct the entry. 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.

Analyzing Complex Transactions Now reconstruct the entry. 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 Now reconstruct the entry.

Partial Cash Investing and Financing Activities A company acquired land for $10,000 by paying $1,000 down and signing a $9,000 note payable.

Partial Cash Investing and Financing Activities Land 10,000 Cash 1,000 Notes Payable 9,000 Make the worksheet entry in journal entry format. Land 10,000 Cash Used For Investing Activities: Purchased Land 1,000 Note Payable 9,000 Reconstruct the entry for the worksheet.

Partial Cash Investing and Financing Activities …and the issuing of the note is shown as a $9,000 financing activity. The purchase of the land is shown as a $9,000 investing activity… Schedule of Noncash Transactions

Partial Cash Investing and Financing Activities A company acquired land for $18,000 by paying $15,000 down and signing a $3,000 note payable. Cash Flows From Investing Activities Purchase of land by issuance of note and cash $(18,000 ) Less: Issuance of note 3,000 Cash payment for purchase of land $15,000

Partial Cash Investing and Financing Activities Land 10,000 Cash 1,000 Notes Payable 9,000 Make the worksheet entry in journal entry format. Land 10,000 Cash Used For Investing Activities: Purchased Land 1,000 Notes Payable 9,000 Reconstruct the entry for the worksheet.

Temporary and Long-Term Investments On November 28, 2007, 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, 2007, 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 (1) Temporary Investment in Available-for Sale Securities 40,000 Cash Flows From Investing Activities: Payment for Purchase of Temporary Investment 40,000 (2) 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 (1) Allowance for Change in Value of Investment 2,000 Unrealized Increase in Value of Available-for-Sale Securities 2,000 (2) No change! The debit portion appears only in the upper portion of the worksheet.

Temporary and Long-Term Investments On January 16, 2008, 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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