1. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin STATEMENT OF CASH FLOWS Chapter 13

2. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO1 Explain the purposes and uses of a statement of cash flows.

3. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Provides information about the cash receipts and cash payments of a business entity during the accounting period. Helps investors with questions about the company’s Helps investors with questions about the company’s Ability to generate positive cash flows. Ability to generate positive cash flows. Ability to meet its obligations and to pay dividends. Ability to meet its obligations and to pay dividends. Need for external financing. Need for external financing. Investing and financing transactions for the period. Investing and financing transactions for the period. Helps investors with questions about the company’s Helps investors with questions about the company’s Ability to generate positive cash flows. Ability to generate positive cash flows. Ability to meet its obligations and to pay dividends. Ability to meet its obligations and to pay dividends. Need for external financing. Need for external financing. Investing and financing transactions for the period. Investing and financing transactions for the period. Purpose of the Statement of Cash Flows

4. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin

5. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO2 Describe how cash transactions are classified in a statement of cash flows.

6. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The Statement of Cash Flows must include the following three sections: Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities The Statement of Cash Flows must include the following three sections: Cash Flows from Operating Activities Cash Flows from Investing Activities Cash Flows from Financing Activities Classification of Cash Flows

7. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO3 Compute the major cash flows relating to operating activities.

8. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin + _ Inflows from: Interest and dividends received. Sales to customers. Inflows from: Interest and dividends received. Sales to customers. Cash Flows from Operating Activities Operating Activities Outflows to: Suppliers of merchandise and services. Employees. Lenders for interest. Governments for taxes. Outflows to: Suppliers of merchandise and services. Employees. Lenders for interest. Governments for taxes.

9. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO4 Compute the cash flows relating to investing and financing activities.

10. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Flows from Investing Activities + _ Inflows from: Selling investments and plant assets. Collecting of principal on loans. Inflows from: Selling investments and plant assets. Collecting of principal on loans. Outflows to: Purchase of investments and plant assets. Purchase debt or equity investments. Make loans. Outflows to: Purchase of investments and plant assets. Purchase debt or equity investments. Make loans. Investing Activities

11. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin + _ Inflows from: Short-term and long-term borrowing. Owners (for example, from issuing stock). Inflows from: Short-term and long-term borrowing. Owners (for example, from issuing stock). Outflows to: Make payments on borrowed funds. Owners for dividends. Purchase treasury stock. Outflows to: Make payments on borrowed funds. Owners for dividends. Purchase treasury stock. Financing Activities Cash Flows from Financing Activities

12. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Equivalents Cash Currency Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes. Short-term, highly liquid investments. Readily convertible into cash. So near maturity that market value is unaffected by interest rate changes. Cash and Cash Equivalents

13. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO5 Distinguish between the direct and indirect methods of reporting operating cash flows.

14. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The operating cash flows section can be prepared using either the direct method or the indirect method. Let’s look at the direct method for preparing the Statement of Cash Flows.

15. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Accrual basis revenue includes sales that did not result in cash inflows. Can be computed as: Cash Received from Customers Decrease in receivables Increase in receivables + – = = Net Sales Direct Method Cash Received from Customers

16. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin + – = = The accounts receivable balance was $80,000 on 12/31/06 and $110,000 on 12/31/07. If accrual sales revenue for 2007 was $900,000, what was cash basis revenue? Decrease in receivables Increase in receivables Net Sales $900,000 Net Sales $900,000 Direct Method Cash Received from Customers Cash Received from Customers

17. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Received from Customers = $870,000 $30,000 Increase in receivables – = Net Sales $900,000 Net Sales $900,000 Direct Method Cash Received from Customers The accounts receivable balance was $80,000 on 12/31/06 and $110,000 on 12/31/07. If accrual sales revenue for 2007 was $900,000, what was cash basis revenue?

18. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Let’s look at some simplified formulas for computing direct method cash flows.

19. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method Interest and Dividends Received

20. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Step 1 Step 2 Direct Method Cash Paid for Merchandise

21. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin How much did Martin Co. pay for inventory in 2007? a. $900,000 b. $923,000 c. $947,000 d. $877,000 Direct Method Cash Paid for Merchandise Purchases for 2007 were $935,000. Purchases = $900,000 + $35,000 Purchases = $900,000 + $35,000 Cash Paid for Merchandise in 2007 was $923,000. Cash Paid = $935,000 - $12,000 Cash Paid = $935,000 - $12,000 Purchases for 2007 were $935,000. Purchases = $900,000 + $35,000 Purchases = $900,000 + $35,000 Cash Paid for Merchandise in 2007 was $923,000. Cash Paid = $935,000 - $12,000 Cash Paid = $935,000 - $12,000

22. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin After deducting depreciation and other noncash expenses, the cash paid for expenses is affected by (1) whether the expense was prepaid, and (2) whether the expense was accrued. After deducting depreciation and other noncash expenses, the cash paid for expenses is affected by (1) whether the expense was prepaid, and (2) whether the expense was accrued. Direct Method Cash Payments for Expenses Cash Paid for Expenses = + Increase in prepaid expenses -Decrease in prepaid expenses + Decrease in accrued liabilities -Increase in accrued liabilities

23. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Now, let’s prepare a direct method Statement of Cash Flows for Martin Co.

24. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method

25. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method

26. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method

27. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method Additional Information Trading Securities were purchased during 2007 at a cost of $25,000. Equipment with a book value of $40,000 was sold during the year for $43,000. Equipment with a book value of $30,000 was destroyed during a freak flood in 2007. There was no insurance. Martin owns 25% of the common stock of another company and uses the equity method to account for this investment. Additional Information Trading Securities were purchased during 2007 at a cost of $25,000. Equipment with a book value of $40,000 was sold during the year for $43,000. Equipment with a book value of $30,000 was destroyed during a freak flood in 2007. There was no insurance. Martin owns 25% of the common stock of another company and uses the equity method to account for this investment.

28. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method Additional Information Martin’s tax rate is 40%. The Notes Payable to the bank carry a 12% rate. The payments are due on the first day of each month. The Bonds Payable carry a 9% rate. Interest is payable semiannually on July 1 & Jan. 1. Sold stock during 2007 for $50,000. Received $10,000 dividends from its equity investment. Additional Information Martin’s tax rate is 40%. The Notes Payable to the bank carry a 12% rate. The payments are due on the first day of each month. The Bonds Payable carry a 9% rate. Interest is payable semiannually on July 1 & Jan. 1. Sold stock during 2007 for $50,000. Received $10,000 dividends from its equity investment.

29. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method Cash Received from Customers Cash Paid to Employees

30. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method Cash Paid for Inventory Cash Paid for Interest

31. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method Cash Paid for Taxes Other Operating Cash Flows

32. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Direct Method Cash Flows From Operating Activities

33. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Equipment with a book value of $40,000 was sold for $43,000. Notes Payable decreased from $70,000 to $60,000 during 2007. Bonds Payable decreased from $250,000 to $150,000 during 2007.

34. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Notice that the Ending Cash Balance per the Statement of Cash Flows agrees with the 12/31/07 Cash balance on the Balance Sheet.

35. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO6 Explain why net income differs from net cash flows from operating activities.

36. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Reconciling Net Income with Net Cash Flows There are two major categories of reconciling items. They include adjusting for: 1.Noncash Expenses. 2.Timing Differences. There are two major categories of reconciling items. They include adjusting for: 1.Noncash Expenses. 2.Timing Differences. Accounts receivable Depreciation Expense

37. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Let’s look at the indirect method that is used by over 97% of all companies.

38. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO7 Compute net cash flows from operating activities using the indirect method.

39. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Net Income Cash Flows from Operating Activities Indirect Method Changes in current assets and current liabilities as shown on the following table. + Losses and - Gains + Noncash expenses such as depreciation and amortization.

40. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Use this table when adjusting Net Income to Operating Cash Flows. Indirect Method

41. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Joyce, Inc. has prepared the Balance Sheet as of March 31, 2006, and March 31, 2007. The Income Statement for the year ended 3/31/07 has also been prepared. Joyce needs help preparing the Statement of Cash Flows using the indirect method. Indirect Method

42. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method The $8,000 gain was the result of selling land costing $32,000 for $40,000 cash during the period.

43. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method

44. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Joyce issued $50,000 of no par common stock to settle the $50,000 note payable.

45. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method

46. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin With the indirect method, always start with the net income or net loss for the period. Indirect Method

47. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method

48. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Accounts receivable decreased. 3/31/07 3/31/06 $23,000 - $40,000 = $(17,000) Accounts receivable decreased. 3/31/07 3/31/06 $23,000 - $40,000 = $(17,000)

49. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Accounts payable increased. 3/31/07 3/31/06 $38,000 - $27,000 = $11,000 Accounts payable increased. 3/31/07 3/31/06 $38,000 - $27,000 = $11,000

50. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Inventory increased. 3/31/07 3/31/06 $350,000 - $300,000 = $50,000 Inventory increased. 3/31/07 3/31/06 $350,000 - $300,000 = $50,000

51. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Salaries payable decreased. 3/31/07 3/31/06 $ 9,000 - $14,000 = $(5,000) Salaries payable decreased. 3/31/07 3/31/06 $ 9,000 - $14,000 = $(5,000)

52. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Add back non-cash expenses. Indirect Method

53. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Subtract gains. Indirect Method

54. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method The operating cash flows amount comes from the schedule just prepared.

55. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Land originally costing $32,000 was sold for $40,000.

56. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Dividends of $20,000 were paid to owners during the year.

57. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Compute the net change in cash for the period.

58. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Indirect Method Complete the Statement of Cash Flows by reconciling beginning cash to ending cash.

59. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Note that the ending cash amount ties back to Joyce’s Balance Sheet at 3/31/07. Indirect Method

60. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin In addition, on the face of the statement or in a supplemental schedule, disclose the $50,000 noncash financing activity. Indirect Method Cash interest payments and cash tax payments must be disclosed.

61. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO8 Discuss the likely effects of various business strategies on cash flows.

62. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Cash Budgets are used by management to plan and forecast future cash flows. Managing Cash Flows

63. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin  Increase collection of accounts receivables.  Keep inventory low.  Delay payment of liabilities.  Plan timing of major expenditures.  Invest idle cash.  Increase collection of accounts receivables.  Keep inventory low.  Delay payment of liabilities.  Plan timing of major expenditures.  Invest idle cash. Managing Cash Flows

64. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Learning Objective LO9 Explain how a worksheet may be helpful in preparing a statement of cash flows.

65. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin The ending cash balance of one month becomes the beginning cash balance of the next month. Using a Spreadsheet

66. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin Financing is needed in June because the company must maintain a minimum cash balance of $10,000. Using a Spreadsheet

67. © The McGraw-Hill Companies, Inc., 2008 McGraw-Hill/Irwin End of Chapter 13