Statement of Cash Flows Chapter 10 © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Learning Objectives Discuss the nature and purpose of the statement of cash flows. Distinguish between operating activities, investing activities, and financing activities. Analyze and calculate the effects of operating activities on cash. Learning objectives appear in the text margins at the start of the section where the corresponding content is taught. Also, the chapter summary is organized by learning objective to aid student mastery of these objectives. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Learning Objectives Analyze and calculate the effects of investing activities on cash. Analyze and calculate the effects of financing activities on cash. Prepare a statement of cash flows using the direct and indirect methods. Learning objectives appear in the text margins at the start of the section where the corresponding content is taught. Also, the chapter summary is organized by learning objective to aid student mastery of these objectives. © Paradigm Publishing, Inc.

Discuss the nature and purpose of the statement of cash flows Learning Objective 1 Discuss the nature and purpose of the statement of cash flows © Paradigm Publishing, Inc.

The Importance of the Statement of Cash Flows Managing cash flow is essential to the success of any business. © Paradigm Publishing, Inc.

Statement of Cash Flows A financial statement primarily intended to provide information about the cash receipts and cash payments of a business during the period of time covered by the income statement Provides users of financial statements with information that allows them to: Observe reasons for changes in a company’s cash balance Judge the company’s ability to pay its debts and to pay dividends to stockholders © Paradigm Publishing, Inc.

Statement of Cash Flows Assess the company’s need to borrow money Discover the reasons for differences between a company’s net income, cash payments, and cash receipts Observe reasons for changes in a company’s financial position, including investment and borrowing activities, during an accounting period © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Learning Objective 2 Distinguish between operating activities, investing activities, and financing activities © Paradigm Publishing, Inc.

Classification of Cash Flows Operating Activities Transactions that enter into the calculation of net income Investing Activities Transactions involving the purchase and sale of long-term assets and transactions that involve making and collecting loans © Paradigm Publishing, Inc.

Classification of Cash Flows Financing Activities Transactions that involve cash receipts or payments from changes in long-term liabilities and stockholders’ equity © Paradigm Publishing, Inc.

Classification of Cash Receipts and Payments © Paradigm Publishing, Inc.

Classification of Cash Receipts and Payments © Paradigm Publishing, Inc.

Classification of Cash Receipts and Payments © Paradigm Publishing, Inc.

Cash and Cash Equivalents The statement of cash flows should explain changes in cash and cash equivalents. Cash Currency and coin on hand and in the bank Cash equivalent A highly liquid, short-term investment that can easily be converted to cash © Paradigm Publishing, Inc.

Cash and Cash Equivalents Examples of cash equivalent include US government Treasury bills Money market investments Commercial paper © Paradigm Publishing, Inc.

Methods of Preparing the Statement of Cash Flows Two acceptable methods of preparing the statement of cash flows Direct Method Indirect Method Both yield identical results The only difference is in the way cash flows from operating activities is determined © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. The Direct Method A format for preparing the statement of cash flows that discloses each major class of cash inflow and cash outflow from operating activities Shows the amount of cash received or paid for revenues and expenses reported on the income statement Recommended by the FASB © Paradigm Publishing, Inc.

Steps in Preparing a Statement of Cash Flows Determine how much cash has changed. Determine the cash provided (used) by operating activities. Determine the cash provided (or used) by investing activities. Determine the cash provided (or used) by financing activities. © Paradigm Publishing, Inc.

Determine How Much Cash Has Changed We can see the change in cash based on the comparative balance sheets for Ajax Company. © Paradigm Publishing, Inc.

Determine How Much Cash Has Changed © Paradigm Publishing, Inc.

Determine How Much Cash Has Changed © Paradigm Publishing, Inc.

Determine How Much Cash Has Changed Why is it important to know how much cash has changed? If a company consistently generates more cash than it uses, the company will be able to reduce debt, grow, make investments in other companies, increase its dividend, and buy treasury stock. © Paradigm Publishing, Inc.

Analyze and calculate the effects of operating activities on cash Learning Objective 3 Analyze and calculate the effects of operating activities on cash © Paradigm Publishing, Inc.

Determine Cash Flows from Operating Activities We are interested in analyzing cash inflows and outflows relating to operating activities. Refer back to Table 22-1 on page 969. © Paradigm Publishing, Inc.

Cash Received from Customers The Combined Statement of Income and Retained Earnings for Ajax Company © Paradigm Publishing, Inc.

Cash Received from Customers The formula: Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash received from customers amounted to $395,000. Cash received from customers + Decrease in Accounts Receivable = Sales revenue or – Increase in Accounts Receivable © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Quick Check Gilbert Corporation reports credit sales of $300,000 on its income statement for the year ending December 31, 20X3. Accounts receivable on January 1, 20X3, amounted to $55,000 and $58,500 on December 31, 20X3. The amount of cash received from customers during 20X3 amounted to $303,500. $300,000. $296,500. $299,000. $302,500. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-1 Klack Company had sales of $256,000 in 20X3, accounts receivable of $45,000 at the beginning of the year, and $51,000 at the end of the year. Calculate the amount of cash received from customers: Cash received from customers: Sales $256,000 Increase in accounts receivable (6,000) Review Quiz 22-1 appears on page 974. Total $250,000 © Paradigm Publishing, Inc.

Cash Received from Interest Income The formula: Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash received from interest income amounted to $4,000. Cash received from interest income + Decrease in Interest Receivable = Interest income or – Increase in Interest Receivable © Paradigm Publishing, Inc.

Cash Received from Dividends The formula: Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash received from dividends amounted to $3,000. Cash received from dividends = Dividend income + Decrease in Dividends Receivable account – Increase in Dividends Receivable or © Paradigm Publishing, Inc.

Cash Paid for Inventory The formula: Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for inventory amounts to $179,000. Payments for inventory = Cost of goods sold Increase in Decrease in and Accounts Payable + – or or © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Quick Check Gilbert Corporation reports cost of goods sold of $300,000 for the year ending December 31, 20X3. Accounts payable on January 1, 20X3, amounted to $55,000 and $58,500 on December 31, 20X3. Merchandise inventory on January 1, 20X3, amounted to $45,000 and $52,500 on December 31, 20X3. The amount of cash paid for inventory during 20X3 amounted to $303,500. $304,000. $307,500. $355,500. $358,500. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-2 Klack Company reported cost of goods sold of $243,000 on its income statement. Klack’s balance sheet showed that Merchandise Inventory increased by $15,400 and Accounts Payable decreased by $14,000. Calculate the amount of cash paid for inventory: Cash paid for inventory: Cost of goods sold $243,000 Increase in merchandise inventory + 15,400 Review Quiz 22-2 appears on page 976. Decrease in accounts payable + 14,000 Total $272,400 © Paradigm Publishing, Inc.

Cash Paid for Operating Expenses The formula: Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for operating expenses amounts to $86,000. Increase in Prepaid Expenses Decrease in Accrued Liabilities Payments for operating expenses Operating expenses other than depreciation + + = or and or Decrease in Prepaid Expenses Increase in Accrued Liabilities – – © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Cash Paid for Interest The formula: Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for interest expense amounts to $6,000. Payment for interest expense = Interest expense + Decrease in Interest Payable – Increase in Interest Payable or © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Quick Check Gilbert Corporation reports interest expense of $25,000 for the year ending December 31, 20X3. Interest payable on January 1, 20X3, amounted to $1,500 and $2,500 on December 31, 20X3. Cash paid for interest expense during 20X3 amounted to $25,000. $26,500. $27,500. $23,500. $24,000. © Paradigm Publishing, Inc.

Cash Paid for Income Taxes The formula: Looking at the income statement and referring back to the balance sheet for Ajax Company, we can see that cash paid for income tax amounts to $30,050. + Decrease in Income Tax Payable Payment for income taxes = Income taxes or – Increase in Income Tax Payable © Paradigm Publishing, Inc.

Operating Activities Section of a Statement of Cash Flows © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-3 Refer to the comparative balance sheet and combined income and retained earnings statement of West Company on page 978. Calculate the net cash flow from operating activities: Cash received from customers: Sales $256,000 Increase in accounts receivable (10,000) Review Quiz 22-3 appears on page 978. Total $246,000 © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-3 Calculate the net cash flow from operating activities: (Continued) Cash paid for inventory: Cost of goods sold $97,400 Increase in merchandise inventory 5,000 Decrease in accounts payable (6,000) Total $96,400 Review Quiz 22-3 appears on page 978. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-3 Calculate the net cash flow from operating activities: (Continued) Cash paid for operating expenses: Operating expenses other than dep. $71,000 Increase in prepaid expenses 1,000 Increase in accrued salaries payable (200) Total $71,800 Review Quiz 22-3 appears on page 978. Cash paid for interest $2,500 Cash paid for income taxes $14,464 © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-3 Calculate the net cash flow from operating activities: (Continued) Summary Cash flows from operating activities: Cash received from customers $246,000 Cash paid for inventory (96,400) Cash paid for operating expenses (71,800) Review Quiz 22-3 appears on page 978. Cash paid for interest (2,500) Cash paid for income taxes (14,464) Net cash inflow from operating activities $60,836 © Paradigm Publishing, Inc.

Analyze and calculate the effects of investing activities on cash Learning Objective 4 Analyze and calculate the effects of investing activities on cash © Paradigm Publishing, Inc.

Determine Cash Flows from Investing Activities We are interested in analyzing cash inflows and outflows relating to investing activities. © Paradigm Publishing, Inc.

Determine Cash Flows from Investing Activities Referring back to the balance sheet for Ajax Company, we can see Ajax made a $60,000 purchase of the stock of Cramer Company. We can also see the Plant Assets section shows a $50,000 increase in the Land account. The purchase of the stock and the land are both investing activities. © Paradigm Publishing, Inc.

Investing Activities Section of a Statement of Cash Flows This partial statement of cash flows appears as Figure 22-3 on page 980. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-4 Using the financial statements of West Company in Review Quiz 22-3, prepare the Cash Flows from Investing Activities section of West’s statement of cash flows: Cash flows from investing activities: Cash paid for purchase of equipment $(2,000) Net cash outflow from investing activities $(2,000) Review Quiz 22-4 appears on page 979. © Paradigm Publishing, Inc.

Analyze and calculate the effects of financing activities on cash Learning Objective 5 Analyze and calculate the effects of financing activities on cash © Paradigm Publishing, Inc.

Determine Cash Flows from Financing Activities © Paradigm Publishing, Inc.

Determine Cash Flows from Financing Activities We are interested in analyzing cash inflows and outflows relating to financing activities. © Paradigm Publishing, Inc.

Determine Cash Flows from Financing Activities Referring back to the balance sheet and the combined income and retained earnings statement for Ajax Company, we can see Ajax has several items that involve the flow of cash from financing activities. The Liabilities section of the balance sheet reveals that a $40,000 note payable was paid and that bonds payable of $100,000 were issued. © Paradigm Publishing, Inc.

Determine Cash Flows from Financing Activities The Stockholders’ Equity section of the balance sheet shows an increase of $44,050, representing stock issued during the year. Referring to the combined income and retained earnings statement, we see dividends of $11,000 were paid to stockholders. © Paradigm Publishing, Inc.

Financing Activities Section of a Statement of Cash Flows This statement of cash flows appears as Figure 22-4 on page 981. © Paradigm Publishing, Inc.

Financing Activities Section of a Statement of Cash Flows This statement of cash flows appears as Figure 22-4 on page 981. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-5 Using the financial statements presented for West Company in Review Quiz 22-3, determine the net cash outflow (or inflow) from financing activities: Cash flows from financing activities: Cash received from sale of stock $ 3,964 Cash paid for notes payable (20,000) Cash paid for dividends (17,800) Review Quiz 22-5 appears on page 981. Net cash outflow from financing activities $(33,836) © Paradigm Publishing, Inc.

Schedule of Noncash Investing and Financing Activities Some investing and financing activities do not involve cash but do represent a significant change in the financial position of the company. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Example Schedule of Noncash Investing and Financing Activities Assume Sawyer Company purchased a building by issuing a mortgage note payable for $500,000 on Mar. 10, 20X6. Sawyer prepared the following journal entry: 20X6 Mar. 10 Building 500,000 Mortgage Note Payable © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Example Schedule of Noncash Investing and Financing Activities This transaction would appear at the bottom of the statement of cash flows as shown below: © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Learning Objective 6 Prepare a statement of cash flows using the direct and indirect methods © Paradigm Publishing, Inc.

Preparing a Statement of Cash Flows—The Indirect Method Provides less information because it does not disclose the individual cash inflows and outflows from operating activities A format that adjusts the net income figure in order to calculate net cash flows from operating activities © Paradigm Publishing, Inc.

Steps in Using the Indirect Method We start out with net income and make the following adjustments: Add depreciation expense. Subtract an increase in current assets other than cash. Add a decrease in current assets other than cash. Add an increase in current liabilities. Subtract a decrease in current liabilities. © Paradigm Publishing, Inc.

Preparing the Operating Activities Using the Indirect Method Referring to the balance sheet and the combined income and retained earnings statement for Ajax Company, we can prepare the operating activities of the statement of cash flows using the indirect method. This statement appears as Figure 22-6 on the bottom of page 984. © Paradigm Publishing, Inc.

Statement of Cash Flows Statement-Indirect Method This statement appears as Figure 22-5 on the top of page 984. © Paradigm Publishing, Inc.

Statement of Cash Flows Statement-Indirect Method This statement appears as Figure 22-5 on the top of page 984. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Quick Check Gilbert Corporation reports net income of $85,000 for the year ending December 31, 20X3. Included in the calculation of net income is depreciation expense of $5,200. Accounts receivable increased $500 and accounts payable decreased $1,200. Cash flows provided by operating activities for 20X3 amount to $85,000. $90,200. $88,500. $89,500. $81,500. © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Review Quiz 15-6 Using the financial statements presented for West Company in Review Quiz 22-3, prepare the Cash Flows from Operating Activities section of the statement of cash flows using the indirect method: Cash flows from financing activities: Net income $62,636 Add depreciation expense 8,000 Subtract increase in accounts receivable (10,000) Review Quiz 22-6 appears on page 984 Subtract increase in merchandise inventory (5,000) Subtract increase in prepaid expenses (1,000) Add increase in accounts payable 6,000 Add increase in accrued salaries payable 200 Net cash inflow from operating activities $60,836 © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Focus on Ethics Refer to the Focus on Ethics box on page 985 in your text. Auditors are supposed to be independent in fact and in appearance. How was this concept violated by Arthur Andersen? © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Joining the Pieces Cash Inflows and Outflows © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Joining the Pieces Cash Inflows and Outflows © Paradigm Publishing, Inc.

© Paradigm Publishing, Inc. Joining the Pieces Cash Inflows and Outflows © Paradigm Publishing, Inc.