1. Prepared by: Patricia Zima, CA Mohawk College of Applied Arts and Technology Chapter 22 Statement of Cash Flows

2. 2 Statement of Cash Flows Introduction to the Statement of Cash Flows Usefulness of the statement of cash flowsUsefulness of the statement of cash flows What is cash?What is cash? Classification of cash flowsClassification of cash flows Format of the statement of cash flowsFormat of the statement of cash flows Appendix 22A - Use of a Worksheet Preparing the worksheetPreparing the worksheet Analyzing transactionsAnalyzing transactions Completing the work sheetCompleting the work sheet Preparing a Statement of Cash Flows Sources of information and steps in the processSources of information and steps in the process First illustration – Tax Consultants Inc.First illustration – Tax Consultants Inc. Second illustration – Eastern Window Products LimitedSecond illustration – Eastern Window Products Limited Third illustration – Yoshi CorporationThird illustration – Yoshi CorporationPerspectives Reporting and disclosure issuesReporting and disclosure issues Cash flow per share informationCash flow per share information Distributable cashDistributable cash Free cash flowFree cash flow Illustrative examplesIllustrative examples Interpreting the statement of cash flowsInterpreting the statement of cash flows InternationalInternational

3. 3 Usefulness of the Statement of Cash Flows The information may help users (investors, creditors, and others) assess the following: 1.Liquidity and solvency – i.e. the entity’s ability to generate future cash flows and its needs for cash resources 2.The amounts, timing, and uncertainty of future cash flows 3.The reasons why net income and net cash flow from operating activities differ

4. 4 Cash and Cash Equivalents Cash Cash on hand Demand deposits Cash Equivalents Investments that are –Short term, –Highly liquid, and –Easily converted to a known amount of cash –Subject to an insignificant risk of change in value All references to Cash include Cash Equivalents when discussing the Statement of Cash Flows

5. 5 The Cash Flow Statement The cash flow statement provides information about: the cash receipts (cash inflows), and uses of cash (cash outflows) during the year Inflows and outflows are reported for: operating activities investing activities, and financing activities during the year

6. 6 Cash Flow Classifications 1.Operating Activities The cash flows resulting from the primary revenue- producing activities of the business, such as Collections from customers Payments to suppliers Payments to employees Payments to CRA for tax Cash flow provided by operating activities necessary for long term sustainability of the business (i.e. to take advantage of new investment opportunities, to pay dividends without seeking external financing etc.)

7. 7 Cash Flow Classifications 2.Investing Activities The acquisition and disposal of long term assets and long-term investments Examples include: Purchase/disposal of capital assets Acquiring an interest in another corporation Cash flow generated by investing activities shows if the business is investing in additional long term assets that will generate profits and increase cash flows in the future

8. 8 Cash Flow Classifications 3.Financing Activities Changes in long-term debt or equity capital Examples include: Issuing debt, or repayment of debt Issuing new shares, or repurchase of currently outstanding shares Provides information to assess potential for future claims to entity’s cash, extent of debt and increased interest charges

9. 9 Exercise E22-1: Identify Transactions Identify each of the transactions as either –Operating activity (mostly working capital accounts) –Investing activity (mostly long-term assets) –Financing activity (mainly long-term liability and equity accounts) –Significant noncash investing or financing activity –None of the above

10. 10 Exercise E22-1: Identify Transactions a)Acquisition of raw materials Operating Activity (noncash) b)Declaration of dividends Financing Activity (noncash) c)Collected cash dividends from HTM investments Operating activity d)Acquisition of a 4% interest in a company Investing Activity e)Contribution to employees’ pension plan Operating Activity f)Equipment leased through capital lease Significant noncash investing and financing activity

11. 11 Exercise E22-1: Identify Transactions g)Office space leased with an operating lease Operating Activity (noncash) h)Paid interest on outstanding debt and amortized the discount Operating Activity i)Paid the supplier from transaction a) Operating Activity j)Acquired land by issuing preferred shares Significant noncash investing and financing activity k)Paid car dealership for vehicles Investing Activity l)Collected a dividend on investment made in d) Operating Activity

12. 12 Statement of Cash Flows: Concept Operatingactivities Investingactivities Financingactivities Inflows CashPool Operatingactivities Investingactivities Financingactivities Outflows

13. 13 Significant Noncash Transactions Transactions that do not involve the direct receipt or disbursement of cash in the period Examples: –Asset purchased, paid for by assuming debt, or issuance of shares –Exchanges of non-monetary assets –Conversion of debt to equity Noncash transactions are not reported on the Statement of Cash Flows If material, they are reported as notes to the statement or in a supplementary schedule to the financial statements

14. 14 Preparing a Statement of Cash Flows Two methods of preparing the operating cash flow section of the Statement of Cash Flows: 1.Indirect method 2.Direct method Indirect method derives operating cash flows from accrual basis income statement Direct method determines operating cash flows directly for each operating source or use of cash

15. 15 In favour of Direct Method Is more consistent with objective of a statement of cash flows Knowing specific sources of cash inflows and purposes of cash outflows helps in estimating future cash flows Lending officers and other investors prefer direct method AcSB encourages use of direct method as it provides additional information

16. 16 Cash Flow from Operations: Indirect Method – Concept Net Income + - EarnedRevenues ExpensesIncurred Operating cash flow Eliminate non-cash revenues Eliminate non-cash charges

17. 17 The Statement of Cash Flows: Indirect Method Accrual Basis Statements Cash Flow Statement Income Statement items and changes in Current Assets and Current Liabilities Operating activities: Adjust net income for accruals, non-cash charges and non- operating gains/losses Balance Sheet: Changes in Non-Current Assets Investing activities: Inflows from sale of assets and outflows for purchases of assets Balance Sheet: Changes in Non-Current Liabilities and Equity Financing activities: Inflows and outflows from loan and equity transactions

18. 18 Format of the Statement of Cash Flows (Indirect Method) Cash flows from operating activities: Net Income (Loss) $ XXX Adjustments (List individual adjustments) $ XX Net cash flow from operating activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Change in cash $ XXX

19. 19 Format of the Statement of Cash Flows (Direct Method) Cash flows from operating activities: Cash receipts (individually): Inflows $ XXX Cash payments (separately): outflows ($ XXX) Net cash flow from operating activities $ XXX Cash flows from financing activities: (List individual inflows and outflows) $ XX Net cash flow from financing activities $ XXX Cash flows from investing activities: (List individual inflows and outflows) $ XX Net cash flow from investing activities $ XXX Change in cash $ XXX

20. 20 Cash Flows from Operations: Direct Method OutflowsInflows Received from customers for cash sales and on accountReceived from customers for cash sales and on account Cash dividends and interest receivedCash dividends and interest received To suppliers for cash purchases and payments on accountTo suppliers for cash purchases and payments on account To employees for salaries and wages paidTo employees for salaries and wages paid To government for taxes paidTo government for taxes paid To lenders for interest paidTo lenders for interest paid To others for expenses paidTo others for expenses paid

21. 21 Indirect Method: Example Tax Consultants Inc. began operations on January 1, 2008. The income statement and balance sheet for year 2008 follow. Income Statement Income Statement Revenues $ 125,000 Less: Operating expenses 85,000 Income before Tax 40,000 Less: Income Tax 6,000 Net Income $ 34,000 A dividend of $14,000 was declared during year.

22. 22 Indirect Method: Example Balance Sheet Dec 31, 2008 Jan 1, 2008 Assets: Cash$ 49,000$-0- Accounts Receivable 36,000 -0- Total $ 85,000$-0- Liabilities and Shareholders’ Equity: Accounts Payable$ 5,000$-0- Common Shares 60,000 -0- Retained Earnings 20,000 -0- Total $85,000$-0-

23. 23 Operating Activities Net Income $34,000 Accounts Receivable +$ 36,000 Accounts Payable +$ 5,000 Accrual Basis Net Income $34,000 Less: Increase in A/R $ 36,000 Add: Increase in A/P $ 5,000 Cash Flow Changes between beginning and ending balances Operations: Net Inflow $3,000 See explanations next slide

24. 24 Operating Activities Accounts Receivable Increased by $36,000 Cash collections are less than revenue recognized Reduce net income by $36,000 to derive cash flows from operations

25. 25 Operating Activities Accounts Payable Increased by $5,000 Cash paid for purchases is less than expenses reported Increase net income by $5,000 to derive cash flows from Operations; net income for the year increases by $5,000

26. 26 Investing and Financing Activities Accrual Basis Common Stock + $60,000 Retained Earnings + $20,000 Beg Bal:$ 0 Net Income: 34,000 less: Dividends (14,000) End Balance:$20,000 Cash Flow Financing Activities: Issue of Shares: $60,000 Dividends paid: ( 14,000) Inflow 46,000

27. 27 Cash Flow Statement: (Indirect Method) - Summary Cash provided by operating activities: $ 3,000 Cash used by investing activities: -0- Cash provided by financing activities: 46,000 Net inflow for the year $ 49,000 Beginning cash balance: $ -0- Cash, end of year $ 49,000

28. 28 Other Items Income statement gains and losses on disposal of long-term assets must be adjusted in determining cash from operations. Why? These result from investing activities, not operating activities and The amount of the cash flow is the proceeds on disposal, not the gain or loss

29. 29 Other Items Income statement gains and losses on redemption of long-term debts must be adjusted in determining cash from operations. Why? These result from financing activities, not operating activities and The amount of the cash flow is the amount paid to redeem the debt, not the gain or loss

30. 30 Direct Method: Concept Cash Receipts Collections from customers From receipts of interest and dividends less Cash Payments To suppliers To employees For operating exp For interest For taxes equals Cashflowfromoperations

31. 31 Cash From Operations: Direct Method Cash receipts from customers: = Revenue from credit sales – Increase in A/R balances = $125,000 – $36,000 = $89,000 Cash payments to suppliers: = cost of goods sold = $85,000 – $5,000 = $80,000 Refer to Tax Consultant Inc. the data for the indirect method.

32. 32 Direct Method: Operating Activities Operating Activities: Cash receipts from customers $ 89000 Cash paid to suppliers (80,000) Cash paid for income taxes (6,000) Net cash inflow $ 3,000

33. 33 Special Items: Amortization Given: 2008 2007 Property, plant, and equipment $277,000 $247,000 Accumulated amortization (178,000) ( 167,000) Other information: Amortization expense$ 33,000 Gain on sale of equipment$ 14,500 During 2008, equipment costing $45,000 was sold for cash Present relevant T- accounts and cash flow information.

34. 34 Special Items: Amortization - Steps Prepare the T-Account for accumulated amortization and determine the accumulated amortization on asset sold Determine cash from sale of equipment Determine any purchases of plant and equipment (at cost) Identify the inflows and outflows affecting the operating and investing sections

35. 35 Special Items: Amortization Accum. amort. (beg): $167,000 Plus: amortization expense $ 33,000 less: amortization on equipment sold (?) $ 22,000 Accum. amort. (ending):$178,000 Accumulated Amortization 1 Equipment sold (cost): $45,000 Less: Accum. amort. on equipment 22,000 Book value of equipment sold 23,000 Add: Gain on sale 14,500 Cash from sale of equipment $37,500 Equipment Sold 2 Beginning balance:$247,000 Add: Purchases (?)$ 75,000 Less: Equipment Sold$ 45,000 Ending balance: $277,000 Prop., Plant, & Equipment 3 Operating Activities: Amortization – Adjust. $ 33,000 Gain on sale ($14,500) Investing Activities: Sale of equipment - inflow $37,500 Asset purchases - outflow ($75,000) Cash Flow Statement 4

36. 36 Reporting and Disclosure Issues CICA Handbook, Section 1540 requires the following separate disclosures: 1.Pre-tax cash flows from extraordinary items 2.Cash flow for interest and dividend payments 3.Income tax cash flows 4.Business combination and business unit/segment disposal cash flows 5.Policy for determining cash and cash equivalents, and its components and a reconciliation of amounts reported on statement of cash flows with amounts reported on balance sheet

37. 37 Cash Flow per Share Information Per CICA Handbook Section 1540, cash flow per share should not be reported in financial statements, except if payable to owners These cash amounts payable to owners can be disclosed in the statement of cash flows or in notes to the statements

38. 38 International There are very few differences between Canadian and international GAAP for the statement of cash flows One difference is that IAS 7 permits a choice for the reporting of interest and dividend receipts and payments – i.e. interest and dividends received may be included with either investing or operating activities and interest and dividends paid may be either financing or operating

39. 39 Copyright © 2007 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by Access Copyright (The Canadian Copyright Licensing Agency) is unlawful. Requests for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his or her own use only and not for distribution or resale. The author and the publisher assume no responsibility for errors, omissions, or damages caused by the use of these programs or from the use of the information contained herein. COPYRIGHT