1. Accounting Principles Second Canadian Edition Prepared by: Carole Bowman, Sheridan College Weygandt · Kieso · Kimmel · Trenholm

2. CASH FLOW STATEMENT CHAPTER 18

3. PURPOSE OF THE CASH FLOW STATEMENT The primary purpose of the cash flow statement is to provide information about the cash receipts and cash payments of an entity during a period. A secondary objective is to provide information about its –Operating activities –Investing activities –Financing activities

4. MEANING OF CASH FLOWS The cash flow statement is usually prepared using cash and cash equivalents as its basis. Cash equivalents are short-term, highly liquid investments that are both 1.readily convertible to known amounts of cash, and 2. so near to their maturity that their market value is relatively insensitive to changes in interest rates.

5. CLASSIFICATION OF CASH FLOWS Operating activities Investing activities Financing activities

6. Include –Cash effects of transactions that create revenues and expenses and –Enter into determination of net income (loss) OPERATING ACTIVITIES Balance Sheet: Noncash Current Assets and Current Liabilities; Income Statement Items

7. Include –Purchasing and disposing of investments and productive long-lived assets using cash and –Lending money and collecting the loans Balance Sheet: Investment and Long-Term Asset Items INVESTING ACTIVITIES

8. Include –Obtaining cash from issuing debt and repaying the amounts borrowed and –Obtaining cash from owners/shareholders and paying them drawings/dividends FINANCING ACTIVITIES Balance Sheet: Long-Term Liability and Equity Items

9. If it does not affect cash, do NOT report in body of cash flow statement Report in separate note to the financial statements SIGNIFICANT NONCASH ACTIVITIES

10. Operating, investing, and financing plus the significant noncash investing and financing activities constitute the general format of the cash flow statement, an example of which is shown on the right. ILLUSTRATION 18-2 FORMAT OF CASH FLOW STATEMENT COMPANY NAME Cash Flow Statement Period Covered Cash flows from operating activities (List of individual items)XX Net cash provided (used) by operating activitiesXXX Cash flows from investing activities (List of individual items) XX Net cash provided (used) by investing activitiesXXX Cash flows from financing activities (List of individual items) XX Net cash provided (used) by financing activitiesXXX Net increase (decrease) in cashXXX Cash at beginning of periodXXX Cash at end of period XXX Note x: Noncash investing and financing activities (List of significant noncash transactions)XXX

11. PREPARING THE CASH FLOW STATEMENT The cash flow statement is prepared differently from the three other basic financial statements. 1.It is not prepared from the adjusted trial balance. 2. The cash flow statement deals with cash receipts and payments, so the accrual concept is not used in the preparation of this statement. The information to prepare this statement usually comes from three sources: 1.Comparative balance sheet 2.Current income statement 3.Additional information

12. ILLUSTRATION 18-3 THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENT ILLUSTRATION 18-3 THREE MAJOR STEPS IN PREPARING THE CASH FLOW STATEMENT + or - The difference between the beginning and ending cash balances can be easily calculated from comparative balance sheets. This step involves analysing not only the current year’s income statement but also comparative balance sheets and selected additional data. XYZ Goods This step involves analysing comparative balance sheet data and selected additional information for their effects on cash. For Sale InvestingFinancing Step 1: Determine the net increase (decrease) in cash. Step 2: Determine net cash provided (used) by operating activities. Step 3: Determine net cash provided (used) by investing and financing activities.

13. STEP 1: DETERMINE NET INCOME (DECREASE) IN CASH

14. STEP 2: DETERMINE NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES Net income must be converted from an accrual basis to a cash basis in the operating activities section Conversion may be done by two methods: –Indirect (used extensively in practice) –Direct

15. INDIRECT AND DIRECT METHODS Both methods arrive at the same total amount of cash provided (used) by operating activities Methods differ in disclosing the items that make up the total amount Choice of methods affects only the operating activities section; the investing and financing activities sections are the same

16. OPERATING ACTIVITIES – INDIRECT METHOD Section 1

17. ILLUSTRATION 18-6 NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIES ILLUSTRATION 18-6 NET INCOME VS. NET CASH PROVIDED BY OPERATING ACTIVITIES The indirect method starts with net income and converts it to net cash provided by operating activities. In other words, it adjusts net income for items that affect reported net income but do not affect cash, as shown below. Earned Revenues Net Income Incurred Expenses Accrual Basis of AccountingCash Basis of Accounting Net Cash Provided (Used) by Operating Activities Eliminate noncash revenues Eliminate noncash expenses

18. NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (B/S: Noncash Current Assets and Current Liabilities) Adjustments to Convert Net Income to Net Cash Provided (Used) by Operating Activities Add*Deduct* Change in Current Asset Account Balance Accounts receivable Decrease Increase Inventory Decrease Increase Prepaid expenses Decrease Increase Other current assets Decrease Increase Change in Current Liability Account Balance Accounts payable Increase Decrease Accrued expenses payable Increase Decrease Other current liabilities Increase Decrease * Add (deduct) change in account balance to net income

19. NET INCOME TO NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES (I/S: Noncash Items) Adjustments to Convert Net Income to Net Cash Provided (Used) by Operating Activities Noncash Items on Income Statement Amortization (of capital assets) expenseAdd Amortization of bond discount to interest expenseAdd Amortization of bond premium to interest expense Deduct Loss on sale of assetAdd Gain on sale of asset Deduct Income from long-term equity investment Deduct

20. NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES Indirect Method – Sample Format Indirect Method – Sample Format

21. OPERATING ACTIVITIES – DIRECT METHOD Section 2

22. CASH RECEIPTS AND CASH PAYMENTS (Direct Method)

23. CASH RECEIPTS FROM CUSTOMERS The relationships among cash receipts from customers, revenues from sales, and changes in accounts receivable is: Cash receipts from customers = Revenues from sales { + Decrease in accounts receivable or – Increase in accounts receivable

24. Cash payments to suppliers = Cost of goods sold { + Increase in inventory or – Decrease in inventory { + Decrease in accounts payable or – Increase in accounts payable CASH PAYMENTS TO SUPPLIERS The relationship among cash payments to suppliers, cost of goods sold, changes in inventory, and changes in accounts payable is:

25. Cash payments for services + Increase in prepaid expenses or – Decrease in prepaid expenses + Decrease in accrued expenses payable or – Increase in accrued expenses payable { Operating dxpenses { = CASH PAYMENTS FOR OPERATING EXPENSES The relationship among cash payments for operating expenses, changes in prepaid expenses, and changes in accrued expenses payable is:

26. Cash payments for income tax { = Income tax expense + Decrease in income tax payable or – Increase in income tax payable CASH PAYMENTS FOR INCOME TAX The relationships among cash payments for income tax, income tax expense, and changes in income tax payable is:

27. Cash flows from operating activities Cash receipts from customers$120,000 Cash payments: To suppliers($75,000) For operating expenses (36,000) For income tax (10,000)(121,000) Net cash used by operating activities (1,000) COMPUTER SERVICES CORPORATION Cash Flow Statement – Direct Method For the Year Ended December 31, 2002 NET CASH PROVIDED (USED) BY OPERATING ACTIVITIES Direct Method – Sample Format Direct Method – Sample Format

28. STEP 3: DETERMINE NET CASH PROVIDED (USED) BY INVESTING AND FINANCING ACTIVITIES

29. Study the balance sheet to determine changes in investments and long-term assets Changes in each short-term investment (unless incorporated as part of cash definition) and long-term account are analysed using selected transaction data to determine the effect, if any, the changes had on cash NET CASH PROVIDED (USED) BY INVESTING ACTIVITIES

30. NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES Study the balance sheet to determine changes in noncurrent liabilities and owner’s/shareholders’ equity Changes in each noncurrent account are analysed using selected transaction data to determine the effect, if any, the changes had on cash

31. Operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash. ILLUSTRATION 18-8 CASH FLOW STATEMENT INDIRECT METHOD COMPUTER SERVICES COMPANY Cash Flow Statement — Indirect Method For the Year Ended December 31, 2002

32. ILLUSTRATION 18-23 CASH FLOW STATEMENT DIRECT METHOD Cash flows from operating activities Cash receipts from customers$120,000 Cash payments: To suppliers$(75,000) For operating expenses (36,000) For income tax (10,000) (121,000) Net cash provided by operating activities (1,000) Cash flows from investing activities Purchase of equipment $(10,000) Net cash used by investing activities (10,000) Cash flows from financing activities Issue of common shares $ 60,000 Payment of cash dividends (15,000) Net cash provided by financing activities 45,000 Net increase in cash 34,000 Cash, January 1 0 Cash, December 31$ 34,000 COMPUTER SERVICES CORPORATION Cash Flow Statement For the Year Ended December 31, 2002 The cash flow statement shows that operating activities used $1,000 cash and investing activities used $10,000 cash, while financing activities provided $45,000 cash.

33. USING CASH FLOWS TO EVALUATE COMPANY Liquidity –Cash current debt coverage ratio Profitability –Cash return on sales ratio –Cash flow per share Solvency –Cash total debt coverage These ratios are cash-based instead of accrual-based

34. CASH CURRENT DEBT COVERAGE Cash current debt coverage indicates the amount of cash to pay off current debt that is generated from operating activities. The ratio provides a better picture of liquidity than using the current ratio because it uses cash provided by operating activities rather than the year-end asset balance. Cash Provided by Operating Activities Average Current Liabilities Cash Current Debt Coverage 

35. CASH RETURN ON SALES Cash return on sales indicates how quickly sales are turned into cash. The company is efficient at turning sales into cash when its cash return on sales is greater than its accrual-based counterpart, the profit margin. Cash Provided by Operating Activities Net Sales Cash Return on Sales 

36. CASH FLOW PER SHARE Cash flow per share indicates the cash flow generated for each common share. Cash Flow from Operating, Investing, and Financing Activities Number of Common Shares Cash Flow per Share 

37. CASH TOTAL DEBT COVERAGE Cash total debt coverage indicates the amount of cash to pay off total debt that is generated from operating activities. The ratio is the cash based counterpart to the debt to total assets ratio. Cash Provided by Operating Activities Average Total Liabilities Cash Total Debt Coverage 

38. COPYRIGHT Copyright © 2002 John Wiley & Sons Canada, Ltd. All rights reserved. Reproduction or translation of this work beyond that permitted by CANCOPY (Canadian Reprography Collective) is unlawful. Request for further information should be addressed to the Permissions Department, John Wiley & Sons Canada, Ltd. The purchaser may make back-up copies for his / 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.