© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin The Statement of Cash Flows Revisited 21

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Chapter 21 Statement of Cash Flows Revisited

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-3 Investing ActivitiesOperating ActivitiesFinancing Activities Sale of operational assets Sale of investments Collections of loans Cash received from revenues Issuance of stock Issuance of bonds and notes CASH INFLOWS Business CASH OUTFLOWS Purchase of operational assets Purchase of investments Loans to others Cash paid for expenses Payment of dividends Repurchase of stock Repayment of debt

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-4 Cash and Cash Equivalents Resources immediately available to pay obligations. Short-term, highly liquid investments. So near maturity that there is insignificant risk of market value fluctuation from interest rate changes. Maturity of 3 months or less

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-5 Cash Equivalents Treasury bill 100,000 Cash 100,000 Inflow or outflow of cash? Neither – moves $100,000 from one cash account to another cash account

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-6 Primary Classifications in the Statement of Cash Flows

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-7 Cash flows from operating activities: Cash inflows: From customers$98 From investment revenue 3 Cash outflows: To suppliers of goods(50) To employees(11) For interest (3) For insurance (4) For income taxes (11) Net cash flows from operating activities$22 Cash flows from investing activities: Purchase of land($30) Purchase of short-term investment (12) Sale of land 18 Sale of equipment 5 Net cash flows from investing activities(19) Cash flows from financing activities: Sale of common shares$26 Retirement of bonds payable(15) Payment of cash dividends (5) Net cash flows from financing activities 6 Net increase in cash $9 Cash balance, January 1 20 Cash balance, December 31$29

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-8 Cash Flows From Operating Activities Cash flows from operating activities are both inflows and outflows of cash that result from activities reported on the income statement.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide 22-9 Income StatementCash Flows from Operating Activities Revenues:Cash inflows: Sales and service revenue Cash received from customers Investment revenue Cash revenue received Noncash revenues and gains (e.g., gain on sale of assets) [Not reported] Less: Expenses:Less: Cash outflows: Cost of goods sold Cash paid to suppliers Salaries expense Cash paid to employees Noncash expenses and losses (depreciation, amortization, bad debts, loss on sale of assets) [Not reported] Interest expense Cash paid to creditors Other operating expenses Cash paid for expenses Income tax expense Cash paid to the government Net incomeNet cash flows from operating activities

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide CASH FLOWS FROM OPERATING ACTIVITIES Direct Method Cash flows from operating activities are the elements of net income, but reported on a cash basis. Cash flows from operating activities: Cash inflows: From customers$98 From investment revenue 3 Cash outflows: To suppliers of goods(50) To employees(11) For interest (3) For insurance (4) For income taxes(11) Net cash flows from operating activities $22

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide CASH FLOWS FROM OPERATING ACTIVITIES Indirect Method Derived indirectly by starting with reported net income and working backwards to convert that amount to a cash basis. Cash flows from operating activities: Net income$12 Adjustments for noncash effects: Gain on sale of land (8) Depreciation expense 3 Loss on sale of equipment 2 Changes in operating assets and liabilities: Increase in accounts receivable (2) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Discount on bonds payable 2 Decrease in prepaid insurance 3 Decrease in income tax payable (2) Net cash flows from operating activities $22

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide CASH FLOWS FROM INVESTING ACTIVITIES Related to the acquisition and disposition of assets, other than (a) inventory and (b) assets classified as cash equivalents. Included in this classification are cash payments to acquire: Property, plant and equipment and other productive assets [except inventories]. Investments in securities [except cash equivalents]. Nontrade receivables. When these assets later are liquidated, any cash receipts from their disposition also are classified as investing activities. Cash Flows from Investing Activities: Purchase of land$(30) Purchase of short-term investments (12) Sale of land 18 Sale of equipment 5 Net cash flows from investing activities (19)

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide CASH FLOWS FROM FINANCING ACTIVITIES Inflows and outflows of cash resulting from the external financing of a business, including cash inflows from: The sale of common and preferred stock The issuance of bonds and other debt securities Subsequent transactions related to these financing transactions are also classified as financing activities, such as: The repurchase of common or preferred stock (retirement or treasury stock) The repayment of debt The payment of cash dividends to shareholders Cash Flows from Financing Activities: Sale of common stock$26 Retirement of bonds payable(15) Payment of cash dividends (5) Net cash flows from financing activities 6

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Significant Noncash Activities Common noncash activities include: Retiring bonds by issuing stock. Retiring debt by transferring noncash assets. Acquiring an asset by issuing a note payable. Acquiring an asset by capital lease.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Cash Flows from Operating Activities

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Direct Method Analyzing Sales Revenue We can compare sales and the change in accounts receivable to determine the amount of cash received from customers. This relationship can be viewed in T–account format as follows: Accounts Receivable _______________________________________ Beginning balance 30 Credit sales100?Cash received (increases A/R)__________(decreases A/R) Ending balance 32 Cash received from customers must have been $98 million.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide SUMMARY ENTRY FOR SALES AND COLLECTION ACTIVITIES Note that even if some of the year's sales were cash sales, say $40 million cash sales and $60 million credit sales, the result is the same: Accounts Receivable _______________________ Beg. bal. 30 Cash sales$40 Credit sales Recd on acct. 58 _______ Cash recd $98 Ending bal. 32 ($ in millions) Entry Cash (received from customers)98 Accounts receivable (given) 2 Sales revenue ($ ) 100

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Analyzing Sales Review Question Accounts Receivable was $40,000 on 1/1/06 and $52,000 on 12/31/06. If total sales revenue for 2006 was $800,000, then how much cash was received from customers? a.$800,000 b.$760,000 c.$812,000 d.$788,000 Accounts Receivable was $40,000 on 1/1/06 and $52,000 on 12/31/06. If total sales revenue for 2006 was $800,000, then how much cash was received from customers? a.$800,000 b.$760,000 c.$812,000 d.$788,000 A/R increased $12,000 during Cash (received from customers)788 Accounts receivable 12 Sales revenue 800 A/R increased $12,000 during Cash (received from customers)788 Accounts receivable 12 Sales revenue 800

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Cost of Goods Sold { Cash Cost + Inventory Increase paid to of - Inventory Decrease Suppliers Goods + A/P Decrease Sold - A/P Increase =

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Cost of Goods Sold UBC sold goods that had cost $60 million. Inventory decreased by $4 million and accounts payable increased by $6 million. ($ in millions) Cost of goods sold 60 Inventory 4 Accounts payable 6 Cash (paid to suppliers)50

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Cost of Goods Sold Review Question Determine how much was paid for inventory in Cost of goods sold $900,000 Inventory Jan. 1 $130,000 Dec. 31 $165,000 Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000 a.$900,000 b.$923,000 c.$947,000 d.$877,000 Determine how much was paid for inventory in Cost of goods sold $900,000 Inventory Jan. 1 $130,000 Dec. 31 $165,000 Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000 a.$900,000 b.$923,000 c.$947,000 d.$877,000

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Cost of Goods Sold Review Question Cost of goods sold 900,000 Inventory 35,000 Accounts payable 12,000 Cash (paid to suppliers) 923,000 Determine how much was paid for inventory in Cost of goods sold $900,000 Inventory Jan. 1 $130,000 Dec. 31 $165,000 Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000 a.$900,000 b.$923,000 c.$947,000 d.$877,000 Determine how much was paid for inventory in Cost of goods sold $900,000 Inventory Jan. 1 $130,000 Dec. 31 $165,000 Accts Pay. Jan. 1 $ 23,000 Dec. 31 $ 35,000 a.$900,000 b.$923,000 c.$947,000 d.$877,000 Cost of goods sold 900 Inventory 35 Accounts payable 12 Cash (paid to suppliers)923

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Direct Method Salaries Expense Cash paid to employees can be determined from the salaries expense. Cash paid to Salaries + Decrease in Payable Employees Expense - Increase in Payable = { Salaries expense x Salaries payable x Salaries payable x Cash (paid to employees) ?

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Salaries Expense Question Determine how much was paid to employees during Salaries expense $700,000 Salaries Pay. Jan. 1 $ 35,000 Dec. 31 $ 10,000 a.$700,000 b.$735,000 c.$725,000 d.$675,000 Determine how much was paid to employees during Salaries expense $700,000 Salaries Pay. Jan. 1 $ 35,000 Dec. 31 $ 10,000 a.$700,000 b.$735,000 c.$725,000 d.$675,000 Salaries expense 700,000 Salaries payable 25,000 Cash (paid to employees) ?

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Direct Method Estimated Expenses Depreciation, Amortization, and Depletion Expenses Depreciation, Amortization, and Depletion Expenses These are non-cash expenses.These are non-cash expenses. They are not disclosed in the SCF using the direct method.They are not disclosed in the SCF using the direct method. Depreciation, Amortization, and Depletion Expenses Depreciation, Amortization, and Depletion Expenses These are non-cash expenses.These are non-cash expenses. They are not disclosed in the SCF using the direct method.They are not disclosed in the SCF using the direct method.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Depreciation UBCs income statement reports depreciation expense of $3 million. ($ in millions) Depreciation expense 3 Accumulated depreciation 3 Depreciation is a noncash expense. It is merely an allocation in the current period of a prior cash expenditure (for the depreciable asset). Therefore, the depreciation entry has no effect on the statement of cash flows.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Bond Interest UBCs bond interest expense is $5 million and $2 million of the bond discount was reduced in The entry that summarizes the recording of bond interest expense: ($ in millions) Bond interest expense 5 Discount on bonds 2 Cash (paid to bondholders)3 If a premium were being reduced, rather than a discount, the cash outflow would be greater than the expense. ?

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Insurance Expense UBCs insurance expense was $7 million. Prepaid insurance decreased by $3 million indicating that cash paid for insurance coverage was $3 million less than the insurance expense for the year. ($ in millions) Insurance expense 7 Prepaid insurance 3 Cash (paid for insurance)4 ?

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Gains and Losses on Sale of Assets Land that originally cost $10 million was sold for $18 million: ($ in millions) Cash 18 Land 10 Gain on sale of land 8 The gain is simply the difference between cash received in the sale of land (reported as an investing activity) and the book value of the land. To report the $8 million gain as a cash flow from operating activities, in addition to reporting $18 million as a cash flow from investing activities, would be double counting.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide LOSS ON SALE OF EQUIPMENT UBC sold equipment for $5 million that had cost $14 million and was half depreciated. ($ in millions) Cash (from sale of equipment) 5 Loss on sale of equipment 2 Accumulated depreciation ($14 x 50%) 7 Buildings and equipment (given) 14 The sale of equipment is an investing activity. Note:The loss is simply the difference between cash received in the sale of equipment (reported as an investing activity) and the book value of the equipment.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Now, lets look at the Indirect Method for presenting the Cash Flows from Operating Activities section.

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide INDIRECT METHOD By the indirect method, the net cash increase or decrease from operating activities is derived indirectly by starting with reported net income and "working backwards" to convert that amount to a cash basis. Net income$12 Adjustments for noncash effects: Increase in accounts receivable (2) Gain on sale of land (8) Decrease in inventory 4 Increase in accounts payable 6 Increase in salaries payable 2 Depreciation expense 3 Discount on bonds payable 2 Decrease in prepaid insurance 3 Loss on sale of equipment 2 Decrease in income tax payable (2) Net cash flows from operating activities$22

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Net Income Adjustments for Noncash Components Amounts that were increases in net income Gains Subtract from net income Amounts that were reductions of net income Depreciation, depletion, and amortization Losses Add back to net income

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Some IS Items Dont Affect Cash Cash Flows from Operating Activities INCOME STATEMENT INDIRECT METHODDIRECT METHOD Net income$12 Adjustments : Sales$100 Investment rev. 3 Gain - sale of land 8Gain - sale of land (8) [Not reported–no cash effect] Cost of goods sold (60) Salaries expense (13) Depreciation exp. (3)Depreciation exp. 3 [Not reported – no cash effect] Interest exp. (5) Insurance exp. (7) Loss - sale of equip. (2)Loss - sale of equip. 2 [Not reported – no cash effect] Income tax exp. (9) Net cash flows from Net cash flows from Net Income$ 12 operating activities operating activities No effect on Cash

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Net Income Adjustments for Changes in Assets and Liabilities IncreaseDecrease Asset - + Liability + -

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide Others Affect Cash, but by an Amount Different from the Expense Cash Flows from Operating Activities INCOME STATEMENT INDIRECT METHODDIRECT METHOD Net income$12 Adjustments : Sales$100Increase in A/R (2)Cash from customers $98 Investment rev. 3[No adjustment]Cash from investments 3 Gain - sale of land 8 Cost of goods sold (60)Decr. in inventory 4 Increase in A/P 6Cash to suppliers (50) Salaries expense (13)Increase in sal. pay. 2Cash to employees (11) Depreciation exp. (3) Interest exp. (5)Decr. in bond disc. 2Cash for interest (3) Insurance exp. (7)Decr. in pred ins. 3Cash for insurance (4) Loss - sale of equip. (2) Income tax exp. (9)Decrease in I.Tax/P (2)Cash paid for taxes (11) Net cash flows from Net cash flows from Net Income$ 12 operating activities operating activities Convert from Accrual to Cash

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide COMPARISON OF DIRECT AND INDIRECT METHODS Cash Flows from Operating Activities INCOME STATEMENT INDIRECT METHODDIRECT METHOD Net income$12 Adjustments : Sales$100Increase in A/R (2)Cash from customers $98 Investment rev. 3[No adjustment]Cash from investments 3 Gain - sale of land 8Gain - sale of land (8) [Not reported–no cash effect] Cost of goods sold (60)Decr. in inventory 4 Increase in A/P 6Cash to suppliers (50) Salaries expense (13)Increase in sal. pay. 2Cash to employees (11) Depreciation exp. (3)Depreciation exp. 3 [Not reported – no cash effect] Interest exp. (5)Decr. in bond disc. 2Cash for interest (3) Insurance exp. (7)Decr. in pred ins. 3Cash for insurance (4) Loss - sale of equip. (2)Loss - sale of equip. 2 [Not reported – no cash effect] Income tax exp. (9)Decrease in I.Tax/P (2)Cash paid for taxes (11) Net cash flows from Net cash flows from Net Income$ 12 operating activities$22 operating activities$22

© 2007 The McGraw-Hill Companies, Inc. McGraw-Hill/Irwin Slide End of Chapter 21