Prepared by Gabriela H. Schneider, CMA; Grant MacEwan College INTERMEDIATE ACCOUNTING INTERMEDIATE ACCOUNTING Sixth Canadian Edition KIESO, WEYGANDT, WARFIELD, IRVINE, SILVESTER, YOUNG, WIECEK

C H A P T E R 23 Statement of Cash Flows

Learning Objectives 1. Describe the purpose and uses of the statement of cash flows. 2. Define cash and cash equivalents. 3. Identify the major classifications of cash flows and explain the significance of each. 4. Contrast the direct and indirect methods of calculating net cash flow from operating activities.

Learning Objectives 5. Differentiate between net income and net cash flows from operating activities. 6. Prepare a statement of cash flows. 7. Read and interpret a statement of cash flows. 8. Identify the financial reporting and disclosure requirements for the statement of cash flows. 9. Use a work sheet to prepare a statement of cash flows.

Statement of Cash Flows Introduction to the Statement Usefulness What is cash? Classification of cash flows Format of the statement Use of a Worksheet Preparation Analysis of transactions Completing the worksheet Preparing a Statement of Cash Flows Sources of information and steps First illustration Second illustration Third illustration Interpreting the statement Reporting and Disclosure Requirements Cash flow statements Cash flow per share Financial reporting example

Usefulness of the Statement of Cash Flows The information may help users assess the following: The entity’s ability to generate future cash flows The entity’s ability to pay dividends and meet obligations The reasons why net income and net cash flow from operating activities differ Cash and non-cash investing and financing activities during the year

Cash and Cash Equivalents Cash Cash on hand Demand deposits Cash Equivalents Investments that are Short term, Highly liquid, and Easily converted to a known amount of cash Not subject to a significant change in value All references to Cash include Cash Equivalents when discussing the Statement of Cash Flows

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

Statement of Cash Flows: Concept Operating activities Investing activities Financing activities Inflows CashPool Operating activities Investing activities Financing activities Outflows

Preparing a Statement of Cash Flows There are TWO methods of preparing the statement of cash flows: Indirect method Direct method The indirect method derives cash flows from accrual basis statements The direct method determines cash flows directly for each source or use of cash

Statement of Cash Flows: Indirect Method - Concept Net Income + - Earned Revenues Expenses Incurred Operating cash flow Eliminate non-cash revenues Eliminate non-cash charges

The Statement of Cash Flows: Indirect Method Accrual Basis StatementsCash Flow Statement Income Statement items and changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals, non-cash charges and non- operating gains/losses 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

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

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

Format of the Statement of Cash Flows: Indirect Method Cash flows from operating activities: Net Income (Loss) $ XXX Adjustments (List individual inflows and outflows) $ XX Net cash flow from operating activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX

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 financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX

Indirect Method: Example Intelmarkets begins operations on January 1, The income statement and balance sheet for year 2000 follow. 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

Indirect Method: Example Balance Sheet Dec 31, 2000 Jan 1, 2000 Assets: Cash$ 25,000$-0- Accounts Receivable 32, Inventory 29, Land 110, Total $196,000$-0- Liabilities and Equity: Accounts Payable$ 24,000$-0- Common Stock 147, Retained Earnings 25, Total$196,000$-0-

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/R $ 32,000 Less: Increase in Inv. $ 29,000 Add: Increase in A/P $ 24,000 Cash Flow Changes between beginning and ending balances Operations: Net Outflow 2,000 See explanations next slide

Operating Activities Accounts Receivable Increased by $32,000 Cash collections are less than revenue recognized Reduce net income by $32,000 to derive cash flows from operations

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

Investing and Financing Activities Land + $110,000 Accrual Basis Common Stock +$147,000 Retained Earnings+$ 25,000 Beg Bal:$ 0 Net Income: 35,000 less: Dividends( 10,000) End Balance:$25,000 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

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

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

Direct Method: Concept Cash Receipts From sale of goods and services to customers From receipts of interest and dividends less Cash Payments To suppliers To employees For operating exp For interest For taxes equals Cash flow from operations

Cash Flow Statement: Direct Method Cash receipts from customers: = Revenue from credit sales + Decrease in A/R balances - Increase in A/R balances = $200,000 - $32,000 = $168,000 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 Refer to the data for the indirect method.

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.

Direct Method: Operating Activities 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

Special Items: Depreciation Given: 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.

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

Special Items: Depreciation Accum. deprec. (beg) :$167,000 Plus: depreciation expense$ 33,000 less: depreciation on equip sold (?)$ 22,000 Accum. deprec. (ending):$178,000 Accumulated Depreciation1 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 Beginning balance:$247,000 Add: Purchases (?)$ 75,000 Less: Equipment Sold$ 45,000 Ending balance:$277,000 Prop, Plant, & Equipment 3 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

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: issue of bonds (payable) for the purchase of land

Using a Worksheet Aid in statement preparation Guidelines for using the worksheet 1.Balance Sheet section – list debit balances separately from credit balances, regardless of the type of account 2.Bottom half of the worksheet is for Statement data – cash outflows and inflows 3.Amounts entered on the worksheet are not journal entries, or entirely debits and credits Top half of the worksheet may be considered debts and credits Bottom half of the worksheet may be considered cash inflows and outflows

Worksheet Format

COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages, caused by the use of these programs or from the use of the information contained herein.