1. The Statement of Cash Flows C hapter 22 COPYRIGHT © 2010 South-Western/Cengage Learning Intermediate Accounting 11th edition Nikolai Bazley Jones An electronic presentation By Norman Sunderman and Kenneth Buchanan Angelo State University

2. 2 Cash Flow Statement Cash is the lifeblood of any company and is critical to its success. Cash flow information is used by both managers and analysts to understand a company’s operations, assess its liquidity, gain insight into its ability to invest in new assets, and evaluate its financing decisions.

3. 3 1.A company’s ability to generate positive future net cash flows 2.A company’s ability to meet its obligations and pay dividends 3.A company’s need for external financing 4.The reasons for differences between a company’s net income and related cash receipts and payments 5.Both the cash and noncash aspects of a company’s financing and investing transactions during the accounting period Purpose of a Cash Flow Statement Helps users assess:

4. 4 Operating Activities Operating activities include transactions involving acquiring (purchasing or manufacturing), selling, and delivering goods for sale, as well as providing services. Inflows Cash receipts from: The sale of goods or services Collection of accounts receivable Collection of interest on loans Receipts of dividends on investments in equity securities Outflows Cash payments to: Suppliers for inventory Employees The government for taxes Lenders for interest Other suppliers for various expenses

5. 5 Investing Activities Investing activities include transactions involving acquiring and selling investments (both current and noncurrent), and lending money and collecting on the loans. Outflows Cash payments for: Acquiring property, plant, and equipment Purchasing investments in other companies Making loans to borrowers Inflows Cash receipts from: Sales of property, plant, and equipment Sales of investments in other companies Principal repayments of loans by borrowers

6. 6 Financing Activities Financing activities include transactions involving obtaining resources from owners and providing them with a return on, and of, their investment, as well as obtaining money and other resources from creditors and repaying the amounts borrowed. Inflows Cash receipts from: Issuing equity securities Issuing bonds Issuing mortgages Issuing notes Other short- or long-term borrowings Outflows Cash payments for: Dividends Repurchase of the company’s equity securities Repayments of amounts borrowed

7. 7 Cash and Cash Equivalents  The cash flow statement is prepared using cash and cash equivalents.  Cash equivalents –Treasury bills –Commercial paper –Money market funds

8. 8 Indirect Method Example Reconciliation

9. 9 Inflows of Cash 1.Decreases in Assets Other than Cash. The sale or other disposal of assets (other than cash) causes an increase because cash is received in exchange for the assets. 2.Increases in Liabilities. The issuance or other incurrence of liabilities causes an increase in cash because cash is received in exchange for the liabilities. 3.Increases in Stockholders’ Equity. Net income and additional investments by owners result in an inflow of cash.

10. 10 Outflows of Cash 1.Increases in Assets Other than Cash. The acquisition of assets (other than cash) causes an decrease because cash is paid in exchange for the assets. 2.Decreases in Liabilities. The payment of liabilities causes an decrease in cash because cash is paid to satisfy the liabilities. 3.Decreases in Stockholders’ Equity. The payment of dividends and the acquisition of treasury stock are two common transactions that result in stockholders’ equity and also cash.

11. 11 Classifications of Cash Flows A.Inflows of Cash. Increases in stockholders’ equity because of revenues, adjusted for changes in current assets and current liabilities that are related to the operating cycle, as well as changes in certain noncurrent assets and liabilities. B.Outflows of Cash. Decreases in stockholders’ equity because of expenses, adjusted for changes in current assets and current liabilities that are related to the operating cycle, as well as changes in certain noncurrent assets and liabilities. Operating Cash Flows ContinuedContinued

12. 12 Classifications of Cash Flows A.Inflows of Cash. Decreases in noncurrent assets and certain current assets. B.Outflows of Cash. Increases in noncurrent assets and certain current assets. A.Inflows of Cash. Increases in noncurrent liabilities, stockholders’ equity, and certain current liabilities. B.Outflows of Cash. Decreases in noncurrent liabilities, stockholders’ equity, and certain current liabilities. Investing Cash Flows Financing Cash Flows

13. 13 Noncash Simultaneous Investing/Financing Transactions  Acquisitions of assets by issuing equity securities  Acquisitions of assets by assuming liabilities such as capital lease obligations  Exchanges of debt securities for equity securities such as the conversion of bonds to common stock  Exchanges of assets for assets  Exchanges of liabilities for liabilities  Exchanges of equity securities such as the conversion of preferred stock to common stock Examples of changes in assets, liabilities, and stockholders’ equity that may be the result of investing and financing activities not affecting cash include:

14. 14 Net Cash Flow From Operating Activities GAAP allows two ways for a company to calculate and report its net cash flow from operating activities on its statement of cash flows.

15. 15 Net Cash Flow From Operating Activities Even though GAAP recommends the direct method, most companies (99%) use the indirect method. The first is called the direct method and the second is the indirect method.

16. 16 Direct Method Under the direct method, a company deducts its operating cash outflows from its operating cash inflows to determine its net cash flow from operating activities.

17. Inflows Collections from customers Collections of interest and dividends Other operating receipts Outflows Payments to suppliers Payments to employees Other operating payments Payments for interest Payments for income taxes Operating Activities—Direct Method 17

18. 18  Accounts receivable decreased by $2,600.  Inventory increased by $2,000.  Accounts payable decreased by $7,000.  Salaries payable increased by $800. Direct Method Example Ryan Corporation Income Statement Sales revenue (cash and accounts receivable)$ 70,000 Less: Cost of goods sold (cash and accounts payable)$(29,000) Salaries expense (cash and salaries payable) (13,000) Depreciation expense (8,000) (50,000) Income before income taxes$ 20,000 Income tax expense (cash) (6,000) Net income $ 14,000

19. 19 Direct Method Example Cash Flows From Operating Activities Cash Inflows: Cash collected from customers$ 72,600 Cash inflows from operating activities$ 72,600 Cash Outflows: Cash paid to suppliers$(38,000) Cash paid to employees(12,200) Cash paid for income taxes (6,000) Cash outflows for operating activities (56,200) Net cash provided by operating activities$16,400

20. 20 Direct Method Example  The $72,600 cash collected from customers is computed by adding the $2,600 decrease in accounts receivable to the $70,000 sales revenue.  The $38,000 cash paid to suppliers is computed by adding the $2,000 increase in inventory and the $7,000 decrease in accounts payable to the $29,000 cost of goods sold.  The $12,200 cash paid to employees is computed by deducting the $800 increase in salaries payable from the $13,000 salaries expense.  The entire $6,000 of income tax expense was paid in cash.

21. 21 Indirect Method Example Net Cash Flow From Operating Activities Net income$14,000 Adjustments for differences between income flows and cash flows from operating activities: Add: Depreciation expense8,000 Decrease in accounts receivable2,600 Increase in salaries payable800 Less: Increase in inventory (2,000) Decrease in accounts payable (7,000) Net cash provided by operating activities$16,400

22. 22 Steps in Visual Inspection Method

23. 23 Leyton Company: Condensed Financial Information

24. 24 Simple Statement of Cash Flows

25. 25 Simple Example: Net Cash Flow From Operating Activities  Because depreciation is deducted in computing net income but does not cause a cash outflow, the $2,300 depreciation expense is added to net income.  The $1,500 increase in accounts payable is added to net income because other operating expenses recorded during the year exceeded the cash payments for these items.  The $2,700 increase in accounts receivable is deducted from net income because service revenues on credit exceeded the cash collections on account.

26. 26 Simple Example: Cash Flows From Investing Activities  The $12,000 paid for the purchase of a building is deducted.  The $3,000 proceeds from the sale of land is added.

27. 27 Simple Example: Cash Flows From Financing Activities  The issuance of a note provided a cash receipt of $7,000.  The $3,500 cash payment of dividends is subtracted.

28. 28 Step 1:Prepare the column headings on a worksheet. Then enter the account title Cash on the first line of the account titles column and list the beginning balance, ending balance, and the change in cash in the respective columns. Step 2:Enter the titles of all the remaining accounts from the balance sheets on the worksheet and list each beginning and ending account balance, and the change in the account balance directly below the cash information. Steps in the Worksheet (Spreadsheet) Method Steps 1–3: Setting up the worksheet ContinuedContinued

29. 29 Step 3:Directly below these accounts, add the following headings: A. Net Cash Flow From Operating Activities B. Cash Flows From Investing Activities C. Cash Flows From Financing Activities D. Investing and Financing Activities Not Affecting Cash Leave sufficient room below each heading so that each type of cash flow may be listed. Steps in the Worksheet (Spreadsheet) Method Steps 1–3: Setting up the worksheet ContinuedContinued

30. 30 Account for all the changes in the noncash accounts. Reconstruct the journal entries that caused the changes in the noncash accounts directly on the worksheet. Use these general rules: A. Start with net income. B. Account for the changes in the current assets (except cash) and current liability accounts. C. Account for the changes in the noncurrent accounts. Steps in the Worksheet (Spreadsheet) Method Step 4: Completion of the worksheet ContinuedContinued

31. 31 Make a final worksheet entry to record the net change in cash. The difference between the total cash inflows and outflows must be equal to the change in the Cash account. Prepare the statement of cash flows and accompanying schedule from the information developed on the worksheet. Steps in the Worksheet (Spreadsheet) Method Step 5: Record the net change in cash Step 6: Prepare the final worksheet entry

32. 32 Jones Company: Condensed Financial Information

33. 33 Changes in Land First, let’s reconstruct the original entry. During the year, the company sold land for $3,900 that cost $2,200. Worksheet Entries for Investing and Financing Activities

34. 34 Cash Flow Worksheet for 2010 (Jones Company)

35. 35 During the year, an earthquake (extraordinary event) occurred that destroyed a building owned by the company with a cost of $10,000 and a book value of $5,200. The company received after-tax cash proceeds of $3,100 from its insurance company. Worksheet Entries for Investing and Financing Activities Changes in Buildings (and Extraordinary Loss)

36. Worksheet Entries for Investing and Financing Activities Now, we can reconstruct the entry. 36

37. 37 Cash Flows From Investing Activities: Proceeds From Building Destroyed by Earthquake3,100 Accumulated Depreciation: Building4,800 Net Cash Flow From Operating Activities: Extraordinary Loss2,100 Buildings10,000 Worksheet Entries for Investing and Financing Activities Changes in Buildings (and Extraordinary Loss)

38. 38 Cash Flow Worksheet for 2010 (Jones Company)

39. 39 On January 1, the company issued bonds payable with a face value of $10,000, receiving proceeds of $9,000. The company amortized $100 of the discount during the year. Worksheet (Spreadsheet) Method Changes in Bonds Payable (and Related Discount)

40. 40 Cash Flow Worksheet for 2010 (Jones Company)

41. 41 Cash Flow Worksheet for 2010 (Jones Company) ContinuedContinued

42. 42 Cash Flow Worksheet for 2010 (Jones Company)

43. 43 Comprehensive Statement of Cash Flows

44. 44  IFRS require a company to include a cash flow statement as one of its basic financial statements.  Contrary to U.S. GAAP, IFRS do not require a company using the direct method to reconcile its net income to its operating cash flows.  IFRS require that the cash paid for any development costs that is capitalized as an intangible asset be reported as an investing cash outflow.  IFRS allow the reporting of dividends and interest paid as either an operating cash outflow or a financing cash outflow. IFRS vs. U.S. GAAP

45. 45  IFRS allow the reporting of dividends and interest received as either an operating cash inflow or an investing cash inflow.  IFRS allow the reporting of bank overdrafts as a financing cash flow.  IFRS allow the reporting of payments of income taxes identified with financing or investing transactions as financing or investing cash outflows.  IFRS allow the reporting of cash flow per share.  IFRS allow more freedom in netting cash receipts and payments. IFRS vs. U.S. GAAP

46. 46 Brandt Company sold equipment with a cost of $2,200 and accumulated depreciation of $700 for $2,100. Here is another situation that was not part of the chapter’s comprehensive problem. Sale of Depreciable Asset

47. 47 Now, we can reconstruct the entry. Sale of Depreciable Asset

48. 48 Sale of Depreciable Asset Cash Flows From Investing Activities: Proceeds From Sale of Equipment2,100 Accumulated Depreciation700 Equipment2,200 Net Cash Flow From Operating Activities: Gain on Sale of Equipment600

49. 49 Retirement of Bonds Assume Rosen Company paid $8,900 to retire bonds with a face value of $10,000 and a book value of $9,700.

50. 50 Bonds Payable10,000 Discount on Bonds Payable300 Cash8,900 Gain on Retirement of Bonds800 Retirement of Bonds  The cash paid of $8,900 is a cash payment for a financing activity.  The gain increased net income but there was no cash inflow from operating activities.  Therefore, the gain from net income is subtracted in the operating activities section.

51. 51 Interest Paid and Income Taxes Paid GAAP requires that a company using the indirect method of reporting its operating cash flows to also disclose its interest paid and income taxes paid.

52. 52 Jones Company had $1,100 of interest expense, including $100 amortization of bond discount. The beginning balance in Interest Payable was $0 and the ending balance was $500. Bond interest expense$1,100 – Increase in interest payable(500) – Bond discount amortization (100) Interest paid$ 500 Bond interest expense$1,100 – Increase in interest payable(500) – Bond discount amortization (100) Interest paid$ 500 Interest Paid and Income Taxes Paid

53. 53 Income tax expense$3,630 – Increase in income taxes payable(630) – Increase in deferred tax liability (180) Income taxes paid$2,820 Income tax expense$3,630 – Increase in income taxes payable(630) – Increase in deferred tax liability (180) Income taxes paid$2,820 The beginning and ending balances in Income Taxes Payable were $1,500 and $2,130, and the beginning and ending balances in Deferred Tax Liability were $1,920 and $2,100. Income Tax Expense was $3,630. Interest Paid and Income Taxes Paid

54. 54 GAAP flexibility GAAP permits flexibility in reporting a company’s net cash from operating activities under the indirect method. That is, the company may show the reconciliation of net income to the net cash provided by (or used in) operating activities in a separate schedule accompanying its statement of cash flows. Flexibility in Reporting

55. 55 Hembrey Company acquired land for $10,000 by paying $1,000 down and signing a $9,000 note payable. Partial Cash Investing and Financing Activities

56. 56 Partial Cash Investing and Financing Activities One method to disclose the effects of this transaction is to report the cash payment on its statement of cash flows and the noncash element on the accompanying schedule of investing and financing activities not affecting cash. Small Amount of Cash

57. 57 Partial Cash Investing and Financing Activities Small Amount of Cash Statement of Cash Flows Cash Flows From Investing Activities Payment for purchase of land$(1,000) Schedule: Investing and Financing Activities Not Affecting Cash Investing Activities Purchase of land for $10,000 by issuance of note$(9,000) Financing activities Issuance of note to acquire land9,000 Statement of Cash Flows Cash Flows From Investing Activities Payment for purchase of land$(1,000) Schedule: Investing and Financing Activities Not Affecting Cash Investing Activities Purchase of land for $10,000 by issuance of note$(9,000) Financing activities Issuance of note to acquire land9,000

58. 58 Lakewood Company acquired land for $18,000 by paying $15,000 down and signing a $3,000 note payable. Partial Cash Investing and Financing Activities

59. 59 Partial Cash Investing and Financing Activities When the amount of cash is large in such an exchange, it may be more appropriate to report the items in the statement of cash flows. Several alternative disclosure formats are acceptable. Large Amount of Cash

60. 60 Partial Cash Investing and Financing Activities Large Amount of Cash Cash Flows From Investing Activities Purchase of land by issuance of note and cash$(18,000) Less: Issuance of note 3,000 Cash payment for purchase of land$(15,000) Cash Flows From Investing Activities Purchase of land by issuance of note and cash$(18,000) Less: Issuance of note 3,000 Cash payment for purchase of land$(15,000)

61. 61 On November 28, 2010, the Dougherty Company purchased 1,000 shares of Bear Company common stock for $40,000 as a temporary investment in available-for-sale securities. On December 31, 2010, the fair value of the stock was $42 per share. 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. Temporary and Long-Term Investments

62. 62 1.Temporary Investment in Available-for-Sale Securities40,000 Cash40,000 2.Temporary Investment in Available-for-Sale Securities40,000 Cash Flows From Investing Activities: Payment for Purchase of Temporary Investments40,000 Temporary and Long-Term Investments ContinuedContinued

63. 63 1.Allowance for Change in Value of Investment 2,000 Unrealized Increase in Value of Available- for-Sale Securities2,000 2.Allowance for Change in Value of Investment2,000 Unrealized Increase in Value of Available- for-Sale Securities2,000 Temporary and Long-Term Investments No change! The debit portion appears only in the upper part of the worksheet.

64. 64 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. 1.Reconstruct the two entries related to this investment. 2.Make the worksheet entry in journal format. Temporary and Long-Term Investments On January 16, 2011, the Dougherty Company sold its investment in Bear Company stock for $45,000.

65. 65 1.Cash45,000 Temporary Investment in Available-for- Sale Securities40,000 Gain on Sale of Temporary Investment5,000 Temporary and Long-Term Investments 2.Cash Flows From Investing Activities: Proceeds From Sale of Temporary Investment45,000 Temporary Investment in Available-for- Sale Securities40,000 Net Cash Flow From Operating Activities: Gain on Sale of Temporary Investment5,000 ContinuedContinued

66. 66 1.Unrealized Increase in Value of Available-for- Sale Securities 2,000 Allowance for Change in Value of Investment2,000 Temporary and Long-Term Investments No change! 2.Unrealized Increase in Value of Available-for- Sale Securities 2,000 Allowance for Change in Value of Investment2,000

67. 67 Financial Institutions  GAAP is different for banks, brokers and dealers in securities, and other similar companies that hold loans for resale on a short- term basis or carry securities in a “trading account.”  The FASB requires that the cash flows from the purchases or sales of these trading accounts be reported in the operating activities section of the statement of cash flows.

68. 68 Financial Institutions Banks and other financial institutions are allowed to report the net cash flows for: 1.Deposits and withdrawals with other financial institutions 2.Time deposits accepted and repaid 3.Loans made to customers and principal collections of these loans

69. 69 Cash Dividends Declared  In some instances, a company will declare a cash dividend in the current year and pay the cash dividend in the next year. –In this case, the cash dividend is handled differently in preparing the worksheet for the statement of cash flows.  When a company follows a policy of declaring a dividend in one year and paying the dividend in the next year, its Dividends Payable account balance will change during each year.  A comparison of the change in the account balance to the dividends reported on the retained earnings statement will determine the worksheet entry necessary to account for the cash dividends.

70. 70 Cash Flows for Compensatory Share Option Plans  If compensation expense for compensatory share option plans is reported for financial purposes but not for income tax purposes, the result is a deferred tax asset for the future deductible amount.  Therefore, on the corporation's statement of cash flows, under the indirect method the increase in compensation expense must be added back to net income and the increase in the deferred tax asset must be subtracted from net income to help determine the net cash flow from operating activities.

71. 71 Cash Flows for Compensatory Share Option Plans Suppose that Petricka Corporation reported net income of $500,000 and had a tax deduction of $800,000 in the current year for compensation expense because employees exercised share options. In previous years, for financial reporting purposes, the corporation had recorded compensation expense of $700,000 for this compensatory share option plan.

72. 72 Cash Flows for Compensatory Share Option Plans If the corporation is subject to a 30% tax rate and uses the indirect method to report its cash flows from operating activities, then it would report the $30,000 [($800,000 – $700,000) × 0.30] excess realized tax benefit on its statement of cash flows: Cash flows from operating activities Net income$500,000 Less: Excess tax benefits from compensatory stock option plan(30,000) Cash flows from financing activities Excess tax benefits from compensatory stock option plan$ 30,000 Cash flows from operating activities Net income$500,000 Less: Excess tax benefits from compensatory stock option plan(30,000) Cash flows from financing activities Excess tax benefits from compensatory stock option plan$ 30,000

73. Inflows Collections from customers Interest and dividends collected Other operating receipts Outflows Payments to suppliers Payments to employees Other operating payments Payments of interest Payments of income taxes Appendix: Operating Cash Flows 73

74. 74 Appendix: Major Adjustments to Convert Income Statement Amounts to Operating Cash Flows

75. 75 Smith Company made cash sales of $30,000 and credit sales of $42,000 during its first year of operations. How much cash was collected from customers? Appendix: Adjustments for Operating Cash Flows Accounts Receivable Bal. 0 42,000 Bal. 5,000 37,000 Sales Revenue 30,000 42,000 Bal. 72,000 Sales Revenue – Increase in Accounts Receivable = Cash Collected from Customers $72,000 – $5,000 = $67,000

76. 76 Smith Company had beginning and ending balances in Salaries Payable of $0 and $1,000, respectively. Salary Expense for the year was $14,000. How much cash was paid to employees? Salaries Expense 13,000 1,000 Bal. 14,000 Sales Revenue Bal. 0 1,000 Bal. 1,000 Salaries Payable – Increase in Salaries Payable = Payments to Employees $14,000 – $1,000 = $13,000 Appendix: Adjustments for Operating Cash Flows

77. 77 Appendix: Procedures for Statement Preparation Normally, under the direct method, a company obtains the information for its statement of cash flows from the following working papers:  Post-closing trial balance (or balance sheet) from previous period  Adjusted trial balance of current period

78. 78 Appendix: Visual Inspection Method  Make adjustments to the applicable revenues for the period to determine the amounts of collections from customers, interest and dividends collected, and other operating receipts.  Make adjustments to the applicable expenses for the period to determine the amounts of payments to suppliers, payments to employees, other operating payments, payments of interest, and payments of income taxes. Under the visual inspection method, the steps to complete the statement of cash flows using the direct method for operation activities are similar to those for the indirect method, except that the information for the cash flows from operating activities section is computed as follows:

79. 79 Appendix: Visual Inspection Method Assume that the following income statement items were taken from the adjusted trial balance of the Betha Company at the end of 2010: Sales revenue$94,000 Interest revenue5,400 Cost of goods sold$43,000 Salaries expense18,500 Depreciation expense11,000 Other expenses4,700 Interest expense9,200 Income tax expense3,900 Debit Credit

80. Appendix: Visual Inspection Method Assume that a comparison of the post-closing trial balance for 2009 with the adjusted trial balance for 2010 shows the following changes in selected balance sheet accounts: Accounts receivable$ 8,200credit (decrease) Interest receivable 1,200debit (increase) Inventory 6,300debit (increase) Prepaid expenses 600debit (increase) Accumulated depreciation11,000credit (increase) Accounts payable4,800credit (increase) Salaries payable500debit (decrease) Discount on bonds payable200credit (decrease) Income taxes payable300credit (increase) Deferred tax liability400credit (increase) Accounts receivable$ 8,200credit (decrease) Interest receivable 1,200debit (increase) Inventory 6,300debit (increase) Prepaid expenses 600debit (increase) Accumulated depreciation11,000credit (increase) Accounts payable4,800credit (increase) Salaries payable500debit (decrease) Discount on bonds payable200credit (decrease) Income taxes payable300credit (increase) Deferred tax liability400credit (increase) 80

81. 81 Appendix: Visual Inspection Method

82. 82 Appendix: Visual Inspection Method

83. 83 Appendix: Steps in Worksheet Approach for Direct Method

84. 84 Appendix: Steps in Worksheet Approach for Direct Method

85. 85 Appendix: Steps in Worksheet Approach for Direct Method

86. 86 Appendix: Steps in Worksheet Approach for Direct Method

87. 87 Appendix: Worksheet and Direct Method Example Assume that the post-closing trial balance and adjusting trial balance were obtained from the Copeland Company’s accounting records.

88. 88 Appendix: Worksheet and Direct Method Example In addition, the following information was included in its accounting records for 2010: 1.Land costing $2,000 was sold for $2,800. 2.Equipment was purchased at a cost of $24,700. 3.Common stock was issued for $10,000. 4.Dividends of $3,500 were declared and paid.

89. 89 Appendix: Cash Flow Worksheet for 2010 (Copeland Company)

90. 90 Appendix: Statement of Cash Flows (Direct Method)

91. 91 C hapter 22 Task Force Image Gallery clip art included in this electronic presentation is used with the permission of NVTech Inc.