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

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

STATEMENT OF CASH FLOWS

Chapter

13


Learning ObjectiveLearning Objective

LO1

Explain the purposes and uses of a statement of

cash flows.


Provides information about the cash receipts and cash payments of a business entity

during the accounting period.

Provides information about the cash receipts and cash payments of a business entity

during the accounting period.

Helps investors with questions about the company’sHelps 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’sHelps 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 FlowsPurpose of the Statement of Cash Flows



LO2

Describe how cash transactions are classified

in a statement of cash flows.


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 FlowsClassification of Cash Flows



LO3

Compute the major cash flows relating to operating

activities.


+

_

Inflows from:• Interest and dividends

received.• Sales to customers.

Inflows from:• Interest and dividends

received.• Sales to customers. Cash

Flows from

Operating Activities

Cash Flows from

Operating Activities

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.



LO4

Compute the cash flows relating to investing and

financing activities.


Cash Flows from

Investing Activities

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 Investing Activities


+

_

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 Financing Activities

Cash Flows from

Financing Activities

Cash Flows from

Financing Activities


Cash Equivalents

CashCashCurrency

• 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 EquivalentsCash and Cash Equivalents



LO5

Distinguish between the direct and indirect

methods of reporting operating cash flows.


The operating cash flows section

can be prepared using either the direct method or

the indirect method.

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.


• Accrual basis revenue includes sales that did not result in cash inflows.

• Can be computed as:

Cash Received from Customers


Decrease in receivablesDecrease in receivables

Increase in receivablesIncrease in receivables

+

–

=

=

Net SalesNet Sales

Direct MethodCash Received from Customers



+

–

=

=

The accounts receivable balance was $80,000 The accounts receivable balance was $80,000 on 12/31/06 and $110,000 on 12/31/07. If on 12/31/06 and $110,000 on 12/31/07. If

accrual sales revenue for 2007 was accrual sales revenue for 2007 was $900,000, what was cash basis revenue?$900,000, what was cash basis revenue?



Decrease in receivablesDecrease in receivables

Increase in receivablesIncrease in receivables

Net Sales

$900,000

Net Sales

$900,000






Cash Received from Customers = $870,000Cash Received from

Customers = $870,000$30,000

Increase in receivables

$30,000 Increase in receivables–

=

Net Sales

$900,000

Net Sales

$900,000








Let’s look at some Let’s look at some simplified simplified

formulas for formulas for computing direct computing direct

method cash method cash flows.flows.


Direct MethodInterest and Dividends Received

Direct MethodInterest and Dividends Received


Step 1

Step 2

Direct MethodCash Paid for Merchandise



How much did Martin Co. pay for inventory in 2007?How much did Martin Co. pay for inventory in 2007?

a.a. $900,000 $900,000b. $923,000b. $923,000c.c. $947,000 $947,000d. $877,000d. $877,000

Inventory, 1/1/07 130,000$ A/P, 1/1/07 23,000$ Inventory, 12/31/07 165,000$ A/P, 12/31/07 35,000$ COGS, 12/31/07 900,000$



Purchases for 2007 werePurchases for 2007 were $935,000.$935,000.

Purchases = $900,000 + $35,000Purchases = $900,000 + $35,000

Cash Paid for Merchandise in 2007 Cash Paid for Merchandise in 2007 waswas $923,000.$923,000.

Cash Paid =Cash Paid = $935,000$935,000 - $12,000- $12,000

Purchases for 2007 werePurchases for 2007 were $935,000.$935,000.

Purchases = $900,000 + $35,000Purchases = $900,000 + $35,000

Cash Paid for Merchandise in 2007 Cash Paid for Merchandise in 2007 waswas $923,000.$923,000.

Cash Paid =Cash Paid = $935,000$935,000 - $12,000- $12,000


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 MethodCash Payments for Expenses

Direct MethodCash Payments for Expenses

Cash Paid for Expenses

= Expenses

+ Increase in prepaid expenses - Decrease in prepaid expenses

+ Decrease in accrued liabilities - Increase in accrued liabilities


Now, let’s prepare a direct

method Statement of

Cash Flows for Martin Co.


Martin Co.Comparative Balance Sheets - Assets

December 31, 2006 2007

Cash 60,000$ 70,370$ Accounts Receivable, net 27,000 35,000 Inventory 230,000 200,000 Trading Securities - 25,000 Equipment, net 500,000 425,000 Investments 100,000 130,000

Total Assets 917,000$ 885,370$

Direct MethodDirect Method


Martin Co.Comparative Balance Sheets - Liabilities and Equity

December 31, 2006 2007

Accounts Payable 15,000$ 12,000$ Salaries Payable 7,000 5,000 Interest Payable 11,950 7,350 Income Tax Payable 20,000 17,000 Notes Payable, Bob's Bank 70,000 60,000 Bonds Payable 250,000 150,000 Premium on Bonds Payable 5,000 4,000

Common Stock 450,000 500,000 Retained Earnings 88,050 130,020

Total Liabilities and Equity 917,000$ 885,370$



Martin Co.Income Statement Amounts

For the Year Ending December 31, 2007

Sales Revenues 800,000$ Cost of Goods Sold 560,000 Depreciation Expense 5,000 Interest Expense 28,050 Income Tax Expense 27,980 Salary Expense 80,000 Other Expenses 71,000 Amortization of Bond Premium 1,000 Gain on Sale of Equipment 3,000 Extraordinary Loss 30,000 Equity in Investee Income 40,000

Net Income 41,970$




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.



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.


Salary Expense 80,000$ 2000Add: Decrease in Salary Payable 2,000

Cash Paid to Employees 82,000$

Salary Expense 80,000$ 2000Add: Decrease in Salary Payable 2,000

Cash Paid to Employees 82,000$

Sales Revenues 800,000$

Less: Increase in A/R (8,000)

Cash Received from Customers 792,000$

Sales Revenues 800,000$

Less: Increase in A/R (8,000)

Cash Received from Customers 792,000$



Cash Paid to Employees


Interest Expense 28,050$ 2000Add: Decrease in Interest Payable 4,600

Cash Paid for Interest 32,650$

Interest Expense 28,050$ 2000Add: Decrease in Interest Payable 4,600

Cash Paid for Interest 32,650$

Cost of Goods Sold 560,000$

Add : Decrease in A/P 3,000 Less: Decrease in Inventory (30,000)

Cash Paid for Inventory 533,000$

Cost of Goods Sold 560,000$

Add : Decrease in A/P 3,000 Less: Decrease in Inventory (30,000)

Cash Paid for Inventory 533,000$


Cash Paid for Inventory

Cash Paid for Interest


Income Tax Expense 27,980$ 2000Add: Decrease in Taxes Payable 3,000

Cash Paid for Taxes 30,980$

Income Tax Expense 27,980$ 2000Add: Decrease in Taxes Payable 3,000

Cash Paid for Taxes 30,980$


Cash Paid for Taxes

Other Operating Cash Flows



Cash Flows From Operating Activities


Martin Co.Statement of Cash Flows

For the Period Ending December 31, 2007

Operating Cash Flows 27,370$

Investing Cash Flows

Proceeds from sale of Equipment 43,000

Financing Cash Flows

Proceeds from sale of Stock 50,000$ Principal paid on Bonds (100,000) Principal paid on Notes (10,000) (60,000)

Net Cash Flows for the Period 10,370$

Add: Beginning Cash Balance 60,000

Ending Cash Balance 70,370$

Equipment with a book value of $40,000 was sold for $43,000.

Equipment with a book value of $40,000 was sold for $43,000.

Notes Payable decreased from $70,000 to $60,000 during 2007.Notes Payable decreased from $70,000 to $60,000 during 2007.

Bonds Payable decreased from $250,000 to $150,000 during 2007.Bonds Payable decreased from

$250,000 to $150,000 during 2007.


Martin Co.Statement of Cash Flows

For the Period Ending December 31, 2007

Operating Cash Flows 27,370$

Investing Cash Flows

Proceeds from sale of Equipment 43,000

Financing Cash Flows

Proceeds from sale of Stock 50,000$ Principal paid on Bonds (100,000) Principal paid on Notes (10,000) (60,000)

Net Cash Flows for the Period 10,370$

Add: Beginning Cash Balance 60,000

Ending Cash Balance 70,370$

Notice that the Ending Cash Balance per the

Statement of Cash Flows agrees with the 12/31/07

Cash balance on the Balance Sheet.

Notice that the Ending Cash Balance per the

Statement of Cash Flows agrees with the 12/31/07

Cash balance on the Balance Sheet.



LO6

Explain why net income differs from net cash flows from operating

activities.


Reconciling Net Income withNet Cash Flows

Reconciling Net Income withNet 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 receivableAccounts receivableDepreciation ExpenseDepreciation Expense


Let’s look at the indirect method that is used by over 97% of all

companies.



LO7

Compute net cash flows from operating activities

using the indirect method.


Net Income

Net Income

Cash Flows from Operating

Activities

Cash Flows from Operating

Activities

Indirect MethodIndirect Method

Changes in current assets and current liabilities as shown on the following table.

Changes in current assets and current liabilities as shown on the following table.

+ Losses and - Gains

+ Losses and - Gains

+ Noncash expenses such as depreciation and

amortization.

+ Noncash expenses such as depreciation and

amortization.


Use this table when adjusting Net Income to Operating Cash Flows.



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.

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.



Joyce, Inc.Income Statement

For the Year Ending 3/31/07

Revenues 727,000$ Operating Expenses (748,000) Depreciation Expense (6,000) Gain on Sale of Land 8,000 Net Loss (19,000)$

Joyce, Inc.Income Statement

For the Year Ending 3/31/07

Revenues 727,000$ Operating Expenses (748,000) Depreciation Expense (6,000) Gain on Sale of Land 8,000 Net Loss (19,000)$


The $8,000 gain was the result of selling land

costing $32,000 for $40,000 cash during the period.

The $8,000 gain was the result of selling land

costing $32,000 for $40,000 cash during the period.



Joyce issued $50,000 of no par common stock to

settle the $50,000 note payable.

Joyce issued $50,000 of no par common stock to

settle the $50,000 note payable.


With the indirect method, always start with the net income or net

loss for the period.

With the indirect method, always start with the net income or net

loss for the period.




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)



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



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



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)


Add back non-cash expenses. Add back non-cash expenses.



Subtract gains. Subtract gains.




The operating cash flows amount comes

from the schedule just prepared.

The operating cash flows amount comes

from the schedule just prepared.



Land originally costing $32,000 was sold for $40,000.

Land originally costing $32,000 was sold for $40,000.



Dividends of $20,000 were paid to owners during the year.

Dividends of $20,000 were paid to owners during the year.



Compute the net change in cash for the period.

Compute the net change in cash for the period.



Complete the Statement of Cash Flows by reconciling beginning

cash to ending cash.

Complete the Statement of Cash Flows by reconciling beginning

cash to ending cash.


Note that the ending cash amount ties back to Joyce’s

Balance Sheet at 3/31/07.

Note that the ending cash amount ties back to Joyce’s

Balance Sheet at 3/31/07.



In addition, on the face of the statement or in a supplemental schedule, disclose the

$50,000 noncash financing activity.

In addition, on the face of the statement or in a supplemental schedule, disclose the

$50,000 noncash financing activity.


Cash interest payments and cash tax payments must be disclosed.

Cash interest payments and cash tax payments must be disclosed.



LO8

Discuss the likely effects of various business

strategies on cash flows.


Cash Budgets are used by management to plan and forecast future cash flows.

Cash Budgets are used by management to plan and forecast future cash flows.

Force m anagem ent to coordinate activities.

Provide managers w ith advance notice of available resources.

Provide targets useful in evaluating performance.

Provide advance w arnings of potential cash shortages.

A C ash Bu d get can b e u sed to:

Managing Cash FlowsManaging Cash Flows


Increase collection of accounts receivables.Increase collection of accounts receivables. Keep inventory low.Keep inventory low. Delay payment of liabilities.Delay payment of liabilities. Plan timing of major expenditures.Plan timing of major expenditures. Invest idle cash.Invest idle cash.

Increase collection of accounts receivables.Increase collection of accounts receivables. Keep inventory low.Keep inventory low. Delay payment of liabilities.Delay payment of liabilities. Plan timing of major expenditures.Plan timing of major expenditures. Invest idle cash.Invest idle cash.

Managing Cash FlowsManaging Cash Flows



LO9

Explain how a worksheet may be helpful in

preparing a statement of cash flows.


Cash BudgetMay June July August

Beginning cash balance 27,500$ 15,000$ -$ -$ Add: Cash receipts 3,500 Total available cash 31,000$

Less: Cash disbursements 16,000 Excess (deficiency) of available cash over cash disbursements 15,000$ Financing neededFinancing repayments - Ending cash balance 15,000$


Beginning cash balance 27,500$ 15,000$ -$ -$ Add: Cash receipts 3,500 Total available cash 31,000$

Less: Cash disbursements 16,000 Excess (deficiency) of available cash over cash disbursements 15,000$ Financing neededFinancing repayments - Ending cash balance 15,000$

The ending cash balance of one month becomes the beginning cash balance of the next month.

The ending cash balance of one month becomes the beginning cash balance of the next month.

Using a SpreadsheetUsing a Spreadsheet



Beginning cash balance 27,500$ 15,000$ 10,000$ 10,000$ Add: Cash receipts 3,500 2,000 9,000 14,000 Total available cash 31,000$ 17,000$ 19,000$ 24,000$

Less: Cash disbursements 16,000 18,000 6,000 8,000 Excess (deficiency) of available cash over cash disbursements 15,000$ (1,000)$ 13,000$ 16,000$ Financing needed 11,000 - - Financing repayments - - 3,000 6,000 Ending cash balance 15,000$ 10,000$ 10,000$ 10,000$


Beginning cash balance 27,500$ 15,000$ 10,000$ 10,000$ Add: Cash receipts 3,500 2,000 9,000 14,000 Total available cash 31,000$ 17,000$ 19,000$ 24,000$

Less: Cash disbursements 16,000 18,000 6,000 8,000 Excess (deficiency) of available cash over cash disbursements 15,000$ (1,000)$ 13,000$ 16,000$ Financing needed 11,000 - - Financing repayments - - 3,000 6,000 Ending cash balance 15,000$ 10,000$ 10,000$ 10,000$

Financing is needed in June because the company must maintain a minimum cash balance of $10,000.Financing is needed in June because the company must maintain a minimum cash balance of $10,000.

Using a SpreadsheetUsing a Spreadsheet


End of Chapter 13End of Chapter 13

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

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