1. Statement of Cash Flows
Principles of Financial and Managerial Accounting
11e
Principles of Corporate Financial Accounting
11e
Chapter 14
Principles of Financial and Managerial Accounting
Using excel for Success
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Prepared by: C. Douglas Cloud
Professor Emeritus of Accounting
Pepperdine University
© 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 use.
Reeve Warren Duchac

2. Learning Objective 1
Describe the cash flow activities reported in the statement of cash flows.

3. LO 1
Reporting Cash Flows
The statement of cash flows reports a firm’s major cash inflows and outflows for a period. It provides useful information about a company’s ability to do the following:
Generate cash from operations
Maintain and expand its operating capacity
Meet its financial obligations
Pay dividends

4. LO 1
Reporting Cash Flows
The statement of cash flows reports cash flows from three types of activities:
Cash flows from operating activities are cash flows from transactions that affect net income.
Cash flows from investing activities are cash flows from transactions that affect investments in the noncurrent assets of the company.
(continued)

5. LO 1
Reporting Cash Flows
Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the company.

6. Cash Flows from Operating Activities
The direct method reports operating cash inflows (receipts) and cash outflows (payments) as follows:
The primary operating cash inflow is cash received from customers.

7. Cash Flows from Operating Activities
The primary operating cash outflows are cash payments for merchandise, operating expenses, interest, and income tax payments.

8. LO 1
Reporting Cash Flows
The indirect method reports the operating cash flows by beginning with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of cash as follows:

9. Cash Flows from Investing Activities
Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.
Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.

10. Cash Flows from Financing Activities
Cash inflows from financing activities normally arise from issuing long-term debt or equity securities.
Cash outflows from financing activities normally include paying cash dividends, repaying long-term debt, and acquiring treasury stock.

11. Noncash Investing and Financing Activities
LO 1
Noncash Investing and Financing Activities
Noncash investing and financing activities are transactions that do not directly affect cash. The effect of such transactions is recorded in a separate schedule that appears at the bottom of the statement of cash flows.

12. LO 1
No Cash Flow Per Share
Cash flow per share should not be reported on a company’s financial statements for the following reasons:
Users may misinterpret cash flow per share as the per-share amount available for dividends.
Users may misinterpret cash flow per share as equivalent to earnings per share.

13. Prepare a statement of cash flows, using the indirect method.
Learning Objective 2
Prepare a statement of cash flows, using the indirect method.

14. LO 2
The Indirect Method
The indirect method of reporting cash flows from operating activities uses the logic that a change in any balance sheet account (including cash) can be analyzed in terms of changes in other balance sheet accounts.
Any change in the cash account can be determined by analyzing changes in liability, stockholders’ equity, and noncash asset accounts.

15. LO 2
Retained Earnings
A good starting point for determining the cash flows from operating activities is to analyze the Retained Earnings account.
The Retained Earnings account for Rundell Inc. is shown below.

16. LO 2
Retained Earnings
Rundell, Inc.
The Retained Earnings account for 2012 indicates that the $80,000 ($108,000 – $28,000) change resulted from net income and cash dividends. The net income of $108,000 is the first amount reported in the Cash Flows from Operating Activities section.

17. Adjustments to Net Income
LO 2
Adjustments to Net Income
Rundell, Inc.
Cash flows from operating activities:
Net income $108,000
Adjustments to reconcile net income to net cash flow from operating activities:
This phrase beginning with “Adjustments to…” is added to indicate that accrual basis net income is being adjusted to arrive at cash flows from operations.

18. LO 2
Step 1
Expenses that do not affect cash are added. Such expenses decrease net income, but do not involve cash payments and, thus, are added to net income. Examples include depreciation of fixed assets and amortization of intangible assets.

19. LO 2
Step 2
Losses and gains on disposal of assets are added or deducted. The disposal (sale) of assets is an investing activity, rather than an operating activity.
Losses on disposal of assets are added back to net income. Gains on disposal of assets are deducted from net income.

20. LO 2
Step 3
Changes in current operating assets and liabilities are added or deducted as follows:
Increases in noncash current operating assets are deducted.
Decreases in noncash current operating assets are added.
Increases in current operating liabilities are added.
Decreases in current operating liabilities are deducted.

21. Adjustments to Net Income
LO 2
Adjustments to Net Income
Rundell, Inc.
Step 1: The account indicates that depreciation for the year was $7,000 for the building.

22. Adjustments to Net Income
LO 2
Adjustments to Net Income
Rundell, Inc.
STEP 2. Deduct the gain on the sale of land of $12,000. The proceeds, which include the gain, are reported in the Investing section of the statement of cash flows. Thus, the gain of $12,000 is deducted from net income in determining cash flows from operating activities.

23. Adjustments to Net Income
LO 2
Adjustments to Net Income
Rundell, Inc.
Accounts receivable (net): The $9,000 increase is deducted from net income. This is because the $9,000 increase in Accounts Receivable indicates that sales on account were $9,000 more than the cash received from customers. Thus, sales (and net income) includes $9,000 that was not received in cash during the year.
(continued)

24. Adjustments to Net Income
LO 2
Adjustments to Net Income
Rundell, Inc.
Inventories: The $8,000 decrease is added to net income. This is because the $8,000 decrease in inventories indicates that the cost of merchandise sold exceeds the cost of merchandise purchased during the year by $8,000.
Accounts payable (merchandise creditors): The $3,200 decrease is deducted from net income. This is because a decrease in Accounts Payable indicates that the cash payments to merchandise creditors exceed the merchandise purchased on account by $3,200.
(continued)

25. Adjustments to Net Income
LO 2
Adjustments to Net Income
Rundell, Inc.
Accrued expenses payable (operating expenses): The $2,200 increase is added to net income. This is because an increase in Accrued Expenses Payable indicates that operating expenses reported on the income statement exceed the cash payments for operating expenses by $2,200.
Income taxes payable: The $500 decrease is deducted from net income. This is because a decrease in Income Taxes Payable indicates that taxes paid exceed the amount of taxes incurred during the year by $500.

26. Dividends Cash dividends of $28,000 were declared during 2012. LO 2
Rundell, Inc.
Cash dividends of $28,000 were declared during 2012.

27. LO 2
Dividends
Rundell, Inc.
However, as can be seen from the Dividends Payable account, only $24,000 was paid.

28. LO 2
Common Stock
Rundell, Inc.
Rundell Inc.’s Common Stock account increased by $8,000 during 2012.

29. LO 2
Common Stock
Rundell, Inc.
The Paid-in Capital in Excess of Par—Common Stock account increased by $40,000 during the year.

30. LO 2
Bonds Payable
Rundell, Inc.
Bonds Payable decreased by $50,000 during 2012, due to retiring the bonds. A check of Rundell’s income statement shows that there was no gain or loss on the retirement.

31. LO 2
Building
Rundell, Inc.
The Building account increased by $60,000.

32. LO 2
Land
Rundell, Inc.
The $45,000 decline in the Land account was from two transactions.

33. LO 2
Land
Rundell, Inc.
The October 12 transaction is the purchase of land for cash of $15,000. This transaction is reported as an outflow of cash in the Investing Activities section.

34. Prepare a statement of cash flows, using the direct method.
Learning Objective 3
Prepare a statement of cash flows, using the direct method.

35. LO 3
The Direct Method
The direct method reports cash flows from operating activities as follows:

36. LO 3
The Direct Method
The final amount reported in the Cash Flows from Operating Activities section will be the same whether the direct or indirect method is used. The methods differ in how the data are obtained, analyzed, and reported.

37. LO 3
The Direct Method
Under the direct method, the income statement is adjusted to cash flows from operating activities as follows:

38. LO 3
The Direct Method
Depreciation Expense is not adjusted or reported as part of cash flows from operating activities.
This is because depreciation does not involve a cash outflow.

39. LO 3
The Direct Method
Gains and losses are also not adjusted, because the cash flow from operating activities is determined directly, rather than by reconciling net income.
Proceeds from the sale of land, which include any gains or losses, are reported as an investing activity.

40. Cash Received from Customers
LO 3
Cash Received from Customers
Rundell, Inc.
Rundell Inc. reports sales of $1,180,000 for To determine the cash received from customers, sales are adjusted by any increase or decrease in Accounts Receivable.

41. Cash Payments for Operating Expenses
LO 3
Cash Payments for Operating Expenses
Rundell, Inc.
Rundell Inc. reports total operating expenses of $203,000, which includes depreciation of $7,000. To determine cash payments for operating expenses, the other operating expenses (excluding depreciation) of $196,000 are adjusted for any increase or decrease in Accrued Expenses Payable.

42. LO 3
Interest Expense
Rundell, Inc.
Rundell Inc. reports interest expense of $8,000. To determine the cash payments for interest, the $8,000 is adjusted for any increases or decreases in Interest Payable.

43. Cash Payments for Income Taxes
LO 3
Cash Payments for Income Taxes
Rundell, Inc.
Rundell Inc. reports income tax expense of $83,000. To determine the cash payments for income taxes, the $83,000 is adjusted for any increases or decreases in Income Taxes Payable.

44. Learning Objective 4
Describe and illustrate the use of free cash flow in evaluating a company’s cash flow.

45. LO 4
Free Cash Flow
Free cash flow measures the operating cash flow available for a company to use after purchasing the property, plant, and equipment (PP&E) necessary to maintain current productive capacity.

46. Free Cash Flow Cash flow from operating activities
Less: Investments in fixed assets to maintain current production
Free cash flow
Positive free cash flow is considered favorable. A company that has free cash flow is able to fund internal growth, retire debt, pay dividends, and enjoy financial flexibility.

47. LO 4
Free Cash Flow
Research in Motion, Inc., maker of BlackBerry® smartphones, had cash flow from operating activities of $1,452 million in a recent fiscal year. The statement of cash flows indicated that the cash invested in property, plant, and equipment was $834 million. The free cash flow would be computed as follows (in millions):
Cash flow from operating activities $1,452
Less: Investment in PP&E needed to maintain current production
Free cash flow $ 618

48. Statement of Cash Flows
The End