Chapter 12 The Statement of Cash Flows Financial Accounting, 11e © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Learning Objectives Describe the principal purposes and uses of the statement of cash flows, and identify its components. Analyze the statement of cash flows. Use the indirect method to determine cash flows from operating activities. Determine cash flows from investing activities. Determine cash flows from financing activities. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Overview of the Statement of Cash Flows Statement of cash flows: Shows how a company’s operating, investing, and financing activities have affected cash during an accounting period. It explains the net increase (or decrease) in cash during the period. Cash: Includes both cash and cash equivalents. Cash equivalents: Can be quickly converted to cash and have a maturity of 90 days or less when they are purchased. Examples: Money market accounts, commercial paper (short-term corporate notes), U.S. Treasury bills © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Purposes and Uses of the Statement of Cash Flows Managers use statement of cash flows to Assess liquidity Determine the company’s dividend policy Evaluate the effects of major policy decisions Investors and creditors use the statement of cash flows to assess a company’s ability to Manage cash flows Generate positive future cash flows Pay its liabilities, dividends, and interest Anticipate the need for additional financing © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Classification of Cash Flows Operating Activities Investing Activities Financing Activities © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Consolidated Statements of Cash Flows © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Operating Activities Operating activities: Business activities that involve the cash inflows and outflows from activities that enter into the determination of net income. Cash inflows in this category include cash receipts from the sale of goods and services and from the sale of trading securities. Trading securities: Type of marketable security bought and sold for the purpose of making a profit in the near term. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Investing Activities Investing activities: Business activities that involve the purchase and sale of property, plant, and equipment and other long-term assets, including long-term investments. Also involve the purchase of short-term marketable securities (other than trading securities) and inflows from their disposal. When inflows are not material, some companies combine cash flows for property, plant, equipment or capital expenditures to show the net amount of outflow. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Financing Activities Financing activities: Business activities that involve: Obtaining resources from stockholders and providing them with a return on their investments. Obtaining resources from creditors and repaying the amounts borrowed or otherwise settling the obligations. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Classification of Cash Inflows and Cash Outflows © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Required Disclosure of Noncash Investing and Financing Transactions Noncash investing and financing transactions: Transactions that involve only long-term assets, long-term liabilities, or stockholders’ equity. Example: Exchange a long-term asset for a long-term liability © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

© 2012 Cengage Learning. All Rights Reserved © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

STOP & APPLY Filip Corporation engaged in the transactions listed below. Identify each transaction as (a) an operating activity, (b) an investing activity, (c) a financing activity, (d) a noncash transaction, or (e) not on the statement of cash flows. (Assume the indirect method is used.) 1. Purchased office equipment. 2. Decreased accounts receivable. 3. Sold land at cost. 4. Issued long-term bonds for plant assets. 5. Increased inventory. 6. Issued common stock. 7. Repurchased common stock. 8. Issued notes payable. 9. Increased taxes payable. 10. Purchased a 60-day Treasury bill. 11. Purchased a long-term investment. 12. Declared and paid a cash dividend. SOLUTION 1. b; 2. a; 3. b; 4. d; 5. a; 6. c; 7. c; 8. c; 9. a; 10. e (cash equivalent); 11. b; 12. c © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Financial Ratio: Cash Flow Yield Cash flow yield: Ratio of net cash flows from operating activities to net income. For Amazon: Cash Flow Yield = Net Cash Flows from Operating Activities ÷ Net Income $3,293 ÷ $902 = 3.7 Times* *Rounded. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Financial Ratio: Cash Flows to Sales Cash flows to sales: Ratio of net cash flows from operating activities to net sales. For Amazon: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Financial Ratio: Cash Flows to Assets Cash flows to assets: Ratio of net cash flows from operating activities to average total assets. For Amazon: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Free Cash Flow Free cash flow: Amount of cash that remains after deducting the funds a company must commit to continue operating at its planned level. Positive free cash flow: Company has met all of its planned cash commitments and has cash available to reduce debt or to expand. Negative free cash flow: Company will have to sell investments, borrow money, or issue stock in the short term to continue at its planned level. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Asking the Right Questions About the Statement of Cash Flows Cash Flows and Net Income What are the primary reasons that the company’s cash flows from operating activities differed from its net income? Investing Activities What were the company’s most important investing activities other than capital expenditures? Financing Activities How did the company manage its financing activities during the year? Cash Flow Trends What has been the trend of cash flows for the company? © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

STOP & APPLY In 2011, Marthy Corporation had year-end assets of $2,400,000, sales of $2,000,000, net income of $400,000, net cash flows from operating activities of $360,000, dividends of $100,000, purchases of plant assets of $200,000, and sales of plant assets of $50,000. In 2010, year-end assets were $2,200,000. Calculate cash flow yield, cash flows to sales, cash flows to assets, and free cash flow. SOLUTION Free Cash Flow = $360,000 - $100,000 - $200,000 + $50,000 = $110,000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Preparation of the Statement of Cash Flows To demonstrate the preparation of the statement of cash flows, Zebra’s income statement for 2011 and its balance sheets for 2011 and 2010 appear in the following slides. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Income Statement © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Comparative Balance Sheets © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Converting from an Accrual Basis to a Cash Basis Direct method: Adjusts each item on income statement from accrual basis to cash basis. Result: A statement that begins with cash receipts from sales and interest and deducts cash payments for purchases, operating expenses, interest payments, and income taxes to arrive at net cash flows from operating activities. Indirect method: Does not require adjusting each item on the income statement. It lists only the adjustments necessary to convert net income to cash flows from operations. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

© 2012 Cengage Learning. All Rights Reserved © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Indirect Method of Determining Net Cash Flows from Operating Activities © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Schedule of Cash Flows from Operating Activities: Indirect Method © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Gains and Losses Financial Statement Information: Zebra’s income statement shows a $12,000 gain on the sale of investments. Operating Cash Flow Analysis: Gain on sale of investments (12,000) Financial Statement Information: Zebra’s income statement shows a $3,000 loss on the sale of plant assets. Loss on sale of plant assets $3,000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Changes in Current Assets Decreases in current assets other than cash have positive effects on cash flows, and increases in current assets have negative effects on cash flows: ▼ A decrease in a current asset frees up invested cash, thereby increasing cash flow. ▲ An increase in a current asset consumes cash, thereby decreasing cash flow. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Changes in Current Assets Financial Statement Information: Zebra’s balance sheet shows an $8,000 decrease in accounts receivable. We can conclude that collections were $8,000 more than sales recorded for the year. Operating Cash Flow Analysis: Decrease in account receivable 8,000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Changes in Current Liabilities The effect that changes in current liabilities have on cash flows is the opposite of the effect of changes in current assets: ▲ An increase in a current liability frees up cash and increases cash flow in the current period. ▼ A decrease in a current liability consumes cash, which decreases cash flow. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Changes in Current Liabilities Financial Statement Information: Zebra’s balance sheet shows a $3,000 increase in accrued liabilities. Operating Cash Flow Analysis: Increase in accrued liabilities is added to net income 3,000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Schedule of Cash Flows From Operating Activities Net Income +/- Reconciling Items = Cash Flows from Operating Activities $16,000 + $14,000 = $30,000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

STOP & APPLY For the year ended June 30, 2011, Saturn Corporation’s net income was $7,400. Its depreciation expense was $2,000. During the year, its Accounts Receivable increased by $4,400, Inventories increased by $7,000, Prepaid Rent decreased by $1,400, Accounts Payable increased by $14,000, Salaries Payable increased by $1,000, and Income Taxes Payable decreased by $600. The company also had a gain on the sale of investments of $1,800. Use the indirect method to prepare a schedule of cash flows from operating activities. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Schedule of Cash Flows from Operating Activities SOLUTION Saturn Corporation Schedule of Cash Flows from Operating Activities For the Year Ended June 30, 2011 Cash flows from operating activities Net income $ 7,400 Adjustments to reconcile net income to net cash flows from operating activities Depreciation $ 2,000 Gain on sale of investments (1,800) Changes in current assets and current liabilities Increase in accounts receivable (4,400) Increase in inventories (7,000) Decrease in prepaid rent 1,400 Increase in accounts payable 14,000 Increase in salaries payable 1,000 Decrease in income taxes payable (600) 4,600 Net cash flows from operating activities $12,000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Determining Cash Flows From Investing Activities Accounts involving cash receipts and cash payments from investing activities are examined individually. The objective is to explain the change in each account balance from one accounting period to the next. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Purchase of Investments Transaction: Purchased investments in the amount of $78,000. Cash Flow Analysis: Purchase of investments ($78,000) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Sale of Plant Assets Transaction: Sold for $5,000 plant assets that cost $10,000 and that had accumulated depreciation of $2,000. Cash Flow Analysis: Sale of plant assets $5,000 Note that this transaction results in a positive cash flow of $5,000, even though the plant assets were sold at a loss of $3,000. The loss on the sale of plant assets is added back to net income. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

STOP & APPLY The following T accounts show Nadia Company’s plant assets and accumulated depreciation at the end of 2011: Plant Assets Accumulated Depreciation Beg. Bal. 65,000 Disposals 23,000 Disposals 14,700 Beg. Bal. 34,500 Purchases 33,600 Depre. 10,200 End. Bal. 75,600 End. Bal. 30,000 Nadia’s income statement shows a gain on the sale of plant assets of $4,400. Compute the amounts that should be shown as cash flows from investing activities, and show how they should appear on Nadia’s 2011statement of cash flows. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Cash flows from investing activities: SOLUTION Cash flows from investing activities: Purchase of plant assets ($33,600) Sale of plant assets 12,700 The T accounts show total purchases of plant assets of $33,600, which is an outflow of cash, and disposal of plant assets that cost $23,000 and that had accumulated depreciation of $14,700. The income statement shows a $4,400 gain on the sale of the plant assets. The cash inflow from the disposal was as follows: Plant assets $23,000 Less accumulated depreciation 14,700 Book value $ 8,300 Add gain on sale 4,400 Cash inflow from sale of plant assets $12,700 Because the gain on the sale is included in the $12,700 in the investing activities section of the statement of cash flows, it should be deducted from net income in the operating activities section. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Determining Cash Flows From Financing Activities Determining cash flows from financing activities is very similar to determining cash flows from investing activities, but the accounts analyzed relate to short-term borrowings, long-term liabilities, and stockholders’ equity. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Bonds Payable (slide 1 of 3) Transaction: Issued $100,000 of bonds at face value in a noncash exchange for plant assets. Cash Flow Analysis: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Bonds Payable (slide 2 of 3) Transaction: Repaid $50,000 of bonds at face value at maturity. Cash Flow Analysis: Repayment of bonds ($50,000) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Bonds Payable (slide 3 of 3) Reconciliation: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Common Stock (slide 1 of 2) Transaction: Issued 15,200 shares of $5 par value common stock for $175,000. Cash Flow Analysis: Issuance of common stock $175,000 © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Common Stock (slide 2 of 2) Reconciliation: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Retained Earnings (slide 1 of 2) Transaction: Paid cash dividends in the amount of $8,000. Cash Flow Analysis: Payment of Dividends ($8,000) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Retained Earnings (slide 2 of 2) Reconciliation: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Treasury Stock (slide 1 of 2) Transaction: Purchased treasury stock for $25,000. Cash Flow Analysis: Purchase of treasury stock ($25,000) © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

EXAMPLE: Treasury Stock (slide 2 of 2) Reconciliation: © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

Statement of Cash Flows: Indirect Method © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom

STOP & APPLY During 2011, Robinson Company issued $1,000,000 in long-term bonds at par, repaid $200,000 of notes payable at face value, issued notes payable of $40,000 for equipment, paid interest of $40,000, paid dividends of $25,000, and repurchased common stock in the amount of $50,000. Prepare the cash flows from financing activities section of the statement of cash flows. SOLUTION Cash flows from financing activities Issuance of long-term bonds $1,000,000 Repayment of notes payable (200,000) Payment of dividends (25,000) Purchase of treasury stock  (50,000) Net cash flows from financing activities $ 725,000 Note: Interest is an operating activity. The exchange of the notes payable for equipment is a noncash investing and financing transaction. © 2012 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom