Chapter 5 – Continued The balance sheet and STATEMENT OF CASH FLOWS Sommers – ACCT 3311 Chapter 1: Environment and Theoretical Structure of Financial Accounting.

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Statement of Cash Flows Purpose of the Statement of Cash Flows To provide relevant information about the cash receipts and cash payments of an enterprise during a period. The statement provides answers to the following questions: Where did the cash come from? What was the cash used for? What was the change in the cash balance?

Focus on Perhaps the most noteworthy item reported on an income statement is net income—the amount by which revenues exceed expenses. The most noteworthy item reported on a statement of cash flows is not the amount of net cash flows. The amount of net cash flows may in fact be the least important number on the statement. The increase or decrease in cash can be seen easily on comparative balance sheets. The purpose of the Statement of Cash Flows is not to report that cash increased or decreased by a certain amount, but why cash increased or decreased by that amount. The individual cash inflows and outflows provide that information.

Discussion Question Q5-24 Differentiate between operating activities, investing activities, and financing activities.

Classification of Cash Flows Balance Sheet Current Assets Current Liabilities Operating Noncurrent Liabilities Noncurrent Assets Investing Financing Equity

Classifying Cash Flows Indicate the reporting classification of each transaction by entering the appropriate classification code. +I Investing activity (cash inflow) –I Investing activity (cash outflow) +F Financing activity (cash inflow) –F Financing activity (cash outflow) N Noncash investing and financing activity X Not reported as an investing and/or a financing activity Sale of land Issuance of common stock for cash Purchase of treasury stock Conversion of bonds payable to common stock Lease of equipment by capital lease Sale of patent

Classifying Cash Flows +I Investing activity (cash inflow) –I Investing activity (cash outflow) +F Financing activity (cash inflow) –F Financing activity (cash outflow) N Noncash investing and financing activity X Not reported as an investing and/or a financing activity Acquisition of building for cash Issuance of common stock for land Collection of note receivable (principal amount) Issuance of bonds Payment of cash dividends Issuance of short-term note payable for cash Issuance of long-term note payable for cash Purchase of marketable securities (“available for sale”)

Classifying Cash Flows +I Investing activity (cash inflow) –I Investing activity (cash outflow) +F Financing activity (cash inflow) –F Financing activity (cash outflow) N Noncash investing and financing activity X Not reported as an investing and/or a financing activity Payment of note payable Sale of equipment Issuance of note payable for equipment Repayment of long-term debt by issuing common stock Loan to another firm Sale of inventory to customers Purchase of marketable securities (cash equivalents)

Reporting Cash Flows from Operating Activities Two Formats for Reporting Operating Activities Reports the cash effects of each operating activity Direct Method Starts with accrual net income and converts to cash basis Indirect Method Note that no matter which format is used, the same amount of net cash flows operating activities is generated.

Direct Method Under the direct method, the cash effect of each operating activity is reported directly in the statement.

Indirect Method By the indirect method, we arrive at net cash flow from operating activities indirectly by starting with reported net income and working backwards to convert that amount to a cash basis.

Noncash Investing and Financing Activities Significant investing and financing transactions not involving cash also are reported (usually in a disclosure note). Acquiring an asset by incurring a debt payable to the seller. Acquiring an asset by entering into a capital lease. Converting debt into common stock or other equity securities. Exchanging noncash assets or liabilities for other noncash assets or liabilities.

Determining Cash Received or Paid When preparing a SCF using direct method, the numbers needed generally are not kept by the accounting system There is not an account that is the amount (balance) of cash paid to suppliers for merchandise Most people get these numbers by backing into them using accounting relations via T-accounts or by using journal entries

Determining Cash Received or Paid Given: Beginning End of year of year Inventory $ 90 $ 93 Accounts payable 14 16 Cost of goods sold 300 Determine cash paid to merchandise suppliers. Cash paid to suppliers for merchandise

Cash from Customers Given: Beginning End of year of year Accounts receivable $ 100 $110 Allowance for bad debts 5 3 Sales revenue 600 Bad debt expense 10 Determine cash received from customers. Cash received from customers

Proceeds from Sale On July 15, 2011, M.W. Morgan Distribution sold land for $35 million that it had purchased in 2006 for $22 million. What would be the amount(s) related to the sale that Morgan would report in its statement of cash flows for the year ended December 31, 2011, using the direct method? The indirect method?

Red, Inc. Cash Flow Problem ∆ – Dr/(Cr) Operating Investing Financing Acct Rec 46 Ppd Insur 4 Inventory 110 Bldgs & Eq 50 Acc Depr-B 121 Acct Pay 13 Accr Exp 5 Note pay (50) Bond pay (160) Comm Stk Ret Earn (53)

Red, Inc. Cash Flow Problem

Statement of Cash Flows For year ended December 31, 2011 Red, Inc. Statement of Cash Flows For year ended December 31, 2011

Statement of Cash Flows For year ended December 31, 2011 Red, Inc. Statement of Cash Flows For year ended December 31, 2011

U.S. GAAP vs. IFRS RELEVANT FACTS Both IFRS and GAAP allow the use of title “balance sheet” or “statement of financial position.” IFRS recommends but does not require the use of the title “statement of financial position” rather than balance sheet. Both IFRS and GAAP require disclosures about (1) accounting policies followed, (2) judgments that management has made in the process of applying the entity’s accounting policies, and (3) the key assumptions and estimation uncertainty that could result in a material adjustment to the carrying amounts of assets and liabilities within the next financial year. Comparative prior period information must be presented and financial statements must be prepared annually. IFRS and GAAP require presentation of noncontrolling interests in the equity section of the balance sheet.

U.S. GAAP vs. IFRS RELEVANT FACTS IFRS requires a classified statement of financial position except in very limited situations. IFRS follows the same guidelines as this textbook for distinguishing between current and noncurrent assets and liabilities. However under GAAP, public companies must follow SEC regulations, which require specific line items. Under IFRS, current assets are usually listed in the reverse order of liquidity. For example, under GAAP cash is listed first, but under IFRS it is listed last. IFRS has many differences in terminology. For example in the equity section common stock is called share capital—ordinary. Use of the term “reserve” is discouraged in GAAP, but there is no such prohibition in IFRS.

Balance Sheet Classification Cone Corporation is in the process of preparing its December 31, 2009, balance sheet. There are some questions as to the proper classification of the following items: $50,000 in cash set aside in a savings account to pay bonds payable. The bonds mature in 2013. Prepaid rent of $24,000, covering the period January 1, 2010, through December 31, 2011. Note payable of $200,000. The note is payable in annual installments of $20,000 each, with the first installment payable on March 1, 2010. Accrued interest payable of $12,000 related to the note payable. Investment in marketable securities of other corporations, $80,000. Cone intends to sell one-half of the securities in 2010. Required: Prepare a partial classified balance sheet to show how each of the above items should be reported.