1. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Chapter 14 1

2. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2 Identify the purposes of the statement of cash flows Distinguish among operating, investing, and financing cash flows Prepare the operating cash flows by the indirect method Identify noncash investing and financing activities

3. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 3 Analyze cash flows Prepare the statement of cash flows by the direct method (Appendix 14A) Prepare the indirect statement of cash flows using a spreadsheet (Appendix 14B)

4. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Identify the purposes of the statement of cash flows 1 1 4

5. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The comparative balance sheet reports financial position Shows whether cash increased or decreased Does not show why cash changed Should we be worried about Exxon’s drop in cash? 5

6. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The statement of cash flows details cash activities Shows where cash came from (receipts) and how cash was spent (payments) Reports why cash increased or decreased during the period Operating Investing Financing 6 X 1,000

7. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Cash inflows: Operating Investing Financing Cash outflows: Operating Investing Financing

8. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 8

9. 9 Predict future cash flows Evaluate management decisions Predict ability to pay debts and dividends

10. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Highly liquid investments Can convert into cash three months or less So close to cash it is considered as equals Examples: Money-market accounts Investments in U.S. government securities 10

11. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Distinguish among operating, investing, and financing cash flows 2 2 11

12. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 12 Day-to-day operations Operating Long-term assets Investing Equity & Long-term liabilities Financing

13. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Inflows: Collections from customers Interest and dividends earned Outflows: Merchandise purchases, payments to workers, interest payments, tax payments Reflects day-to-day operation success Cash inflow: core business is making money Cash outflow: core business is losing money 13

14. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The business investing in long term assets, or selling them Computers, software, land, buildings, equipment Or loaning to outsiders (or reversal) Or investing in outside companies (or reversal) Cash outflows: The business is investing in their future This is normally good, if they can afford it Cash inflows: The business may be selling off productive assets, hurting their ability to grow in the future 14

15. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Sourcing capital, return on capital, and return of capital Good or bad depends on many factors Business life cycle Utilization of capital Performance or potential in operating and investing Inflows: borrowing, selling stock Outflows: repaying loans, repurchasing stock, paying dividends 15

16. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Buy a building and equipment Operating Cash Flows Investing Cash Flows Financing Cash Flows Owners invest in the businessBuy inventoryCollect cash from customersPay employee wagesBorrow money from bankPay dividends to ownersPay interest on the loanSell the truck to raise cash

17. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. We are a start up and our business operations are still burning through cash Operating Cash Flows Investing Cash Flows Financing Cash Flows We are generating tremendous amounts of cash from our core business activities We are a mature business, earning tons of cash from operations, with no appealing growth prospects. Our business grew too large using too much debt, and we can’t cover the interest payments. We are bankrupt, the doors are shut.

18. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. www.yahoo.com/finance www.google.com/finance www.sec.gov CAT SNA CVX you tube videoyou tube video …………..

19. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare operating cash flows by the indirect method 3 3 19

20. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 20 Current assets Long-term assets Current liabilities Long-term liabilities Owners’ equity Operating cash flows Investing cash flows Financing cash flows

21. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Indirect method Starts with net income; adjusts it to net cash provided by operating activities Used by most companies Direct method Restates income statement in terms of cash Shows cash receipts and payments from operating activities Different computations, but same operating cash flows end result Investing and financial cash flows are always direct 21

22. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 22

23. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 23

24. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Net Income Cash Flows from Operating Activities Changes in current assets and current liabilities. + Losses and – Gains (non- operating activities) + Noncash expenses such as depreciation and amortization.

25. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Net Income Cash Flows from Operating Activities Changes in current assets and current liabilities. + Losses and – Gains (non- operating activities) + Noncash expenses such as depreciation and amortization.

26. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Net Income Cash Flows from Operating Activities Changes in current assets and current liabilities as shown on the table. + Losses and – Gains (non- operating activities) + Noncash expenses such as depreciation and amortization.

27. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.  Income Statement 1st Record Net Income Remove/counter gains, losses, and non-cash expenses (eg. depreciation & other ‘tions)  Balance Sheet 2nd Add or subtract current accounts to convert Net income to Cash Flow If Balance change takes a debit –Subtract from Net Income If Balance change takes a credit –Add to Net Income

28. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.  Income Statement 1st Record Net Income Remove/counter gains, losses, and non-cash expenses (eg. depreciation & other ‘tions)  Balance Sheet 2nd Add or subtract current accounts to convert Net income to Cash Flow If Balance change takes a debit –Subtract from Net Income If Balance change takes a credit –Add to Net Income

29. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

30. The following slide is a mess It represents what we are really doing when we create an operating activities cash flow statement using the indirect method. Don’t try this at work. 30

31. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 31

32. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 32  Income Statement 1st Record Net Income Remove/counter gains, losses, and non-cash expenses (eg. depreciation & other ‘tions)  Balance Sheet 2nd Add or subtract current accounts to convert Net income to Cash Flow If Balance change takes a debit –Subtract from Net Income If Balance change takes a credit –Add to Net Income

33. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. One Way Cellular accountants have assembled the following data for the year ended September 30, 2012: Prepare the operating activities section using the indirect method for One Way Cellular’s statement of cash flows for the year ended September 30, 2012. 33 Payment of dividends$6,100Net income$ 55,000 Depreciation expense20,000Purchase of equipment39,000 Cash receipt from sale of land34,000 Decrease in current liabilities19,000 Cash receipt from issuance of common stk.30,000 Increase in current assets other than cash14,000

34. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 34 One Way Cellular Statement of Cash Flows – Operating only Year Ended September 30, 2012 Cash flows from operating activities Net income:$55,000 Adjustments to reconcile net income to net cash provided by operating activities Depreciation$20,000 Increase in current assets other than cash(14,000) Decrease in current liabilities(19,000)(13,000) Net cash provided by operating activities$42,000

35. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 35 Destiny Corporation is preparing its statement of cash flows by the indirect method. Destiny has the following items for you to consider in preparing the statement: Identify each item as a(n): Operating activity—addition to net income (O+), or subtraction from net income (O–) Investing activity—addition to cash flow (I+), or subtraction from cash flow (I–) Financing activity—addition to cash flow (F+), or subtraction from cash flow (F–) Activity that is not used to prepare the indirect cash flow statement (N) a. Increase in accounts payablef. Loss on sale of land b. Payment of dividendsg. Depreciation expense c. Decrease in accrued liabilitiesh. Increase in inventory d. Issuance of common stocki. Decrease in accounts receivable e. Gain on sale of buildingj. Purchase of equipment O+ F- O- F+ O- O+ O- O+ I-

36. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 36

37. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 37 Items from the income statement not affecting cash

38. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 38 Net decrease in cash. The answer you are working towards.

39. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 39 Effect on cash If an increase If a decrease Current assets Current liabilities

40. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Refer to the balance sheet for changes in the accounts 40 Operations provided net cash flow of $70,000. This amount exceeds net income of $40,000.

41. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Sales and acquisitions of long-term assets Plant assets and investments Analyze accounts to determine activity Use T-account or journal entries to solve for cash Factor gains/losses and depreciation expenses into the cash flow 41

42. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Combine all the plant assets into a single Plant assets account Find the cost of the sold assets The missing value in our net T-account 42

43. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Solve cash received using the T-account and journal entry Adding the cost of the sold asset to the gain yields cash received 43

44. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

45.  Income Statement 1st Record Net Income Remove/counter gains, losses, and non-cash expenses (eg. depreciation & other ‘tions)  Balance Sheet 2nd Add or subtract current accounts to convert Net income to Cash Flow If Balance change takes a debit –Subtract from Net Income If Balance change takes a credit –Add to Net Income

46. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

47. 47

48. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Issuances of and payments on long-term notes payable Issuances of stock and purchases of treasury stock Payments of dividends Use T-accounts and journal entries to solve for cash, just like investing activities 48

49. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall.

53. Page 685 Compute cash paid for equipment purchases Compute cash paid to reduce long term notes payable Use T accounts to solve for cash flow 53

54. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Review balance sheet for differences Note increase in Long-term notes payable If new issuances or payments are known, the other can be calculated If unknown, review account for debits and credits With knowledge of a new note, note payments can be calculated 54

55. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Review balance sheet for differences Note change in Common stock of $120,000 If either new issuances or purchases are known, the other can be calculated If unknown, review account for debits and credits 55

56. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Review balance sheet for differences Note change in Treasury stock of $20,000 If either new issuances or purchases are known, the other can be calculated If unknown, review account for debits and credits 56

57. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Review balance sheet for differences in Retained earnings Note change in Retained earnings Retained earnings is changed by net income, net losses and dividends Net income of $40,000 is indicated on the income statement Cannot have both income and loss 57

58. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Use the data in Short Exercise 14-5 to complete this exercise. Prepare One Way Cellular’s Financing cash flows from the given information. 58 Payment of dividends$6,100Net income$ 55,000 Depreciation expense20,000Purchase of equipment39,000 Cash receipt from sale of land34,000 Decrease in current liabilities19,000 Cash receipt from issuance of common stk.30,000 Increase in current assets other than cash14,000

59. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 59 One Way Cellular Statement of Cash Flows—Partial Year Ended September 30, 2012 Net cash provided by operating activities$ 42,000 Cash flows from investing activities: Acquisition of equipment$ (39,000) Cash receipt from sale of land34,000 Net cash used for investing activities(5,000) Cash flows from financing activities: Cash receipt from issuance of common stock$ 30,000 Payments of cash dividends(6,100) Net cash provided by financing activities23,900 Net increase in cash$ 60,900

60. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 60

61. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Identify noncash investing and financing activities 4 4 61

62. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Investing and financing activities that do not affect cash Some examples are: Acquired building by issuing stock Acquired land by issuing note payable Paid note payable by issuing common stock Reported in separate schedule or in a note Key—Cash not listed in entry to record transaction 62

63. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Judy’s Makeup Shops earned net income of $22,000, which included depreciation of $14,000. Judy’s acquired a $119,000 building by borrowing $119,000 on a long-term note payable. 1. How much did Judy’s cash balance increase or decrease during the year? 63 Net income$22,000 Depreciation14,000 Purchase of building with long-term notes0 Increase in cash$36,000

64. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 2. Were there any noncash transactions for the company? If so, show how they would be reported in the statement of cash flows. 64 Yes, acquisition of building with long-term note payable reported in non-cash investing and financing activities.

65. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Analyze cash flows 5 5 65

66. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Cash available from operations after: Paying for planned investments in long-term assets Paying dividends to shareholders Used to manage operations If investment opportunity is available, cash is free to invest 66

67. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Cooper Lopez Company expects the following for 2012: Net cash provided by operating activities of $158,000. Net cash provided by financing activities of $60,000. Net cash used for investing activities of $80,000 (no sales of long- term assets). Cash dividends paid to shareholders was $10,000. 1. How much free cash flow does Lopez expect for 2012? 67 $158,000 – 80,000 – 10,000 = $68,000 NCOA - Payments for planned - invest. Payments of cash = dividends Free cash flow

68. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 68

69. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare the statement of cash flows by the direct method (Appendix 14A) 6 6 69

70. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Preferred by FASB Provides clearer information about cash receipts and payments Normally not used by private companies Takes more computations Only operating activities presentation changes Net cash flow from operating activities has the same amount of cash Investing and Financing sections not changed 70

71. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Net cash provided is the same as indirect method 71

72. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 72 STEP 1: Lay out the operating section by the direct method STEP 2: Use the comparative balance sheet to determine the increase or decrease in cash STEP 3: Use the available data to prepare the statement of cash flows Reports only transactions with cash effects Essentially a cash-basis income statement

73. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 73 First item on income statement Sales Total of all sales, whether for cash or on account Yields cash collected from customers Formula or Sales revenue – Increase in Accounts receivable Cash collections from customers Sales revenue + Decrease in Accounts receivable Cash collections from customers

74. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 74 Second item on income statement Interest revenue Related account is Interest receivable Receivable account indicates some not received Formula or Interest revenue – Increase in Interest receivable Cash collections from interest Interest revenue + Decrease in Interest receivable Cash collections from interest

75. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 75 Third item on income statement Dividend revenue Related account is Dividend receivable Receivable account indicates some not received Formula or Dividend revenue – Increase in Dividend receivable Cash collections from dividends Dividend revenue + Decrease in Dividend receivable Cash collections from dividends

76. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 76 Payments to suppliers include all payments for inventory and operating expenses Formula Cost of goods sold – Decrease in Inventory – Increase in Accounts payable = Cash paid for Inventory Cost of goods sold + Increase in Inventory + Decrease in Accounts payable = Cash paid for Inventory

77. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 77 Payments to suppliers include all payments for inventory and operating expenses Formula Other operating expenses + Decrease in Accrued liabilities = Cash paid for operating expenses Other operating expenses – Increase in Accrued liabilities = Cash paid for operating expenses

78. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 78 Payments to suppliers include all payments for inventory and operating expenses Formula Cash paid for Inventory + Cash paid for operating expenses = Cash paid to suppliers

79. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 79 Payments to employees includes salaries, wages, other employee compensation Formula Salary expense or Wages expense + Decrease in Accrued salaries = Cash paid to employees Salary expense or Wages expense – Increase in Accrued salaries = Cash paid to employees

80. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 80 Payments for interest include all payments of interest on notes and bonds Formula Interest expense + Decrease in Accrued interest = Cash paid for interest Interest expense – Increase in Accrued interest = Cash paid for interest

81. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 81 Payments for income taxes for all payments of taxes on income Formula Income tax expense + Decrease in Income tax payable = Cash paid for income tax Income tax expense – Increase in Income tax payable = Cash paid for income tax

82. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Add them all together 82

83. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Prepare the indirect statement of cash flows using a spreadsheet (Appendix 14B) 7 7 83

84. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Companies face complex accounting situations Spreadsheet can help Four column spreadsheet Includes beginning and ending account balances The center left and right columns are for transactional analysis 84

85. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. a.Net income of $40,000 is the first operating cash inflow b.Next come the adjustments to net income c.Removes the gain on the sale of assets d.Entries D–G balance changes in current assets and liabilities h.Long-term asset changes i.Change in Common stock j.Entries J–K balance changes in Long-term liabilities l.L–M balance changes in Retained earnings and Treasury stock n. Final item is the Net decrease in cash 85

86. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Each letter matches an item in the statement of cash flows 86 Change in cash from beginning to end Net Income Starting point Each letter matches an item in the statement of cash flows

87. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 87 Each letter matches an item in the statement of cash flows Change in cash from beginning to end

88. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Journal Entries, core accounting principles utilization: Any and all transactions exemplifying those principles Adjusting Entries: P4-24A Balance sheet or Income statement: P5-32A Allowance for uncollectible accounts: E8-15 Inventory Flow, FIFO, LIFO, Avg. cost: E6-16 Fully Amortizing Notes Payable: E11-14 + in class lesson Bonds, Premium/Discount: E11-16 Stockholders’ Equity transactions w/Treasury Stock & balance sheet presentation: E12-15, E12-21, E13-12, E13-15, 13-16, p/e ratio Operating Activities Cash Flows, indirect method: P14-27A Financial Statement analysis: All analysis HW + p/e ratio Expect interpretation and analysis on any and all topics.

89. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. The statement of cash flows explains why the cash balance does not equal net income (loss) from the income statement. Cash on the statement of cash flows includes cash equivalents. Cash equivalents are assets so close to being cash that they are treated like cash. The statement helps users predict future cash flows, evaluate management decisions, and predict the company’s ability to pay debts and dividends. 89

90. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Operating activities reflect the day-to-day business operations. Operating activities affect current assets and current liabilities. Investing activities report purchase and sales of long-term assets, such as buildings and long- term (nontrade) loans receivable. Financing activities reflect the capitalization of the business and include increases and decreases in long-term liability and equity accounts, paying dividends, and treasury stock transactions. 90

91. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Only the operating activities section is presented differently between the indirect and direct methods. The indirect cash flow statement begins with operating activities. Net income (or net loss) from the income statement is the first item listed. Then, adjustments are made based on changes in current asset and current liability accounts to derive cash provided by (used for) operating activities. 91

92. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Then, investing activities are reported, showing cash used to purchase or cash received from selling long-term assets. Finally, financing activities are reported, showing cash used to pay long-term liabilities, to pay cash dividends, or to purchase treasury shares AND cash received from issuing new long-term liabilities or issuing stock. The total of the cash flows from the three activities (operating, investing, and financing) equals the change in the cash balance. 92

93. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Companies make investments that do not require cash. They also obtain financing other than cash. Such transactions are called noncash investing and financing activities and appear in a separate part of the cash flow statement. Free cash flow measures the amount of cash available from normal operations after paying for planned investments in long-term assets and after paying cash dividends to shareholders. 93

94. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Appendix 14A - The Financial Accounting Standards Board (FASB) prefers the direct method of reporting cash flows from operating activities. The direct method provides clearer information about the sources and uses of cash than does the indirect method. Appendix 14B - The T-account approach works well as a learning device. In practice, however, most companies face complex situations. In these cases, a spreadsheet can help in preparing the statement of cash flows. 94

95. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. 95

96. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Copyright All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America. 96

97. Copyright © 2012 Pearson Education, Inc. Publishing as Prentice Hall. Journal Entries, some perpetual inventory, core accounting principles application: Adjusting Entries: Balance sheet or Income statement: Allowance for doubtful accounts: Inventory Flow, FIFO, LIFO, Avg. cost: Fully Amortizing Notes Payable: Bonds, Premium/Discount: Stockholders’ Equity transactions w/Treasury Stock & balance sheet presentation: Operating Activities Cash Flows, indirect method: Financial Statement analysis Expect interpretation and analysis on any and all topics.