Cash Flows by Kieso

5/21/2018 Cash Flows by Kieso

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STATEMENT OF CASH FLOWS


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1. Describe the purpose of the statement of cash flows.

2. Identify the major classifications of cash flows.

3. Differentiate between net income and net cash flow from operating

activities.

4. Contrast the direct and indirect methods of calculating net cash flow

from operating activities.

5. Determine net cash flows from investing and financing activities.

6. Prepare a statement of cash flows.

7. Identify sources of information for a statement of cash flows.

8. Discuss special problems in preparing a statement of cash flows.

9. Explain the use of a worksheet in preparing a statement of cash flows.

Learning Objectives


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Preparation of theStatement

Special Problems inStatement

PreparationUse of a Worksheet

Usefulness

Classification of cashflows

Cash and cashequivalents

Format of statement

Steps in preparation

Examples

Sources of information

Indirect vs. directmethod

Adjustments to netincome

Accounts receivable (net)

Other working capitalchanges

Net losses

Disclosures

Preparation ofworksheet

Analysis oftransactions

Preparation of finalstatement

Statement of Cash Flows


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23-4 LO 1 Descr ibe the purpo se of the statement o f cash f lows .

Primary purpose:

To provide information about a companys cash receipts

and cash payments during a period.

Secondary objective:

To provide cash-basis information about the companys

operating, investing, and financing activities.

Section 1 - Preparation of theStatement of Cash Flows


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23-5 LO 1 Descr ibe the purpo se of the statement o f cash f lows .

Provides informationto help assess:

1. Entitys ability to generate future cash flows.

2. Entitys ability to pay dividends and obligations.

3. Reasons for difference between net income and net

cash flow from operating activities.

4. Cash and noncash investing and financing transactions.

Usefulness of the Statement of Cash Flows


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IncomeStatement

Transactions

Operating

Activities

Changes inInvestments and

Long-Term

Asset Items

Investing

Activities

Changes inLong-Term

Liabilities and

Stockholders

Equity

Financing

Activities

Classification of Cash Flows

LO 2 Ident i fy the major classi f icat ions o f cash f lows .

IFRS allowssome flexibility regarding

the classification of certain items such as

interest, dividends, and taxes.


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Illustration 23-1Classification of TypicalCash Inflows andOutflows




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Illustration 23-1Classification of TypicalCash Inflows andOutflows


LO 2


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The basis recommended by the IASB for the statement ofcash flows is actually cash and cash equivalents. Cash

equivalentsare short-term, highly liquid investments that are

both:

Readily convertible to known amounts of cash, and

So near their maturity that they present insignificant risk of

changes in value (e.g., due to changes in interest rates).

Cash and Cash Equivalents

Generally, only investments with original maturities of three

months or lessqualify under this definition.



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Typical

Company

Product Life

Cycle




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Format of the Statement of Cash Flows

Presentation:

1. Operating activities.

2. Investing activities.

3. Financing activities.

Direct Method

Indirect Method

Reportinflows and outflows from investing and financing

activities separately.



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Format of the Statement of Cash Flows

Illustration 23-2



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Three Sourcesof Information:

1. Comparative statements of financial position.

2. Current income statement.

3. Selected transaction data.

Steps in Preparation

Three Major Steps:

Step 1. Determine change in cash.

Step 2. Determine net cash flow from operating activities.

Step 3. Determine net cash flows from investing and

financing activities.



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First Example - 2010

Illustration: Tax Consultants Inc. started on January 1, 2010,when it issued 60,000 shares of $1 par value common stock

for $60,000 cash. The company rented its office space,

furniture, and equipment, and performed tax consulting

services throughout the first year.

The comparative statements of financial position at the

beginning and end of the year 2010 appear in Illustration 23-3.

Illustration 23-4 shows the income statement and additionalinformation for Tax Consultants.



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Illustration 23-3Illustration 23-3

ComparativeStatementsof Financial Position,Tax Consultants Inc.,

Year 1

Illustration 23-4Income Statement,

Tax ConsultantsInc.,Year 1


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Step 1: Determine the Change in CashIllustration 23-3



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Company must determine revenues and expenses on a

cash basis.

Eliminatethe effects of income statement transactions

that do not result in an increase or decrease in cash.

Convert net income to net cash flow from operating

activities through either a directmethod or an indirect

method.

Step 2: Determine the Net Cash Flow fromOperating Activities

LO 3 Dif ferent iate between net incom e and net cash f low from operat ing act iv i t ies.


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Step 2: Determine the Net Cash Flow fromOperating Activities

Illustration 23-5Net Income versus Net CashFlow from Operating Activities

LO 3 Dif ferent iate between net incom e and net cash f low from operat ing act iv i t ies.


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Deducts operating cash disbursements from operating cash

receipts.

LO 4 Contrast the direct and indirect methods of calculat ingnet cash f low from operat ing act iv i t ies.

Net cash provided by operating activities is the equivalent of

cash basis net income.

Illustration 23-6


Direct Method


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23-20 LO 4

Illustration 23-6


Accounts Receivable

1/1/10 Balance 0

Revenues 125,000

Receipts from customers 89,000

12/31/10 Balance 36,000

Direct Method

Illustration 23-7


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Accounts Payable

1/1/10 Balance 0

Operating expenses 85,000

12/31/10 Balance 5,000

Payments for expenses 80,000

Illustration 23-6Direct Method

LO 4


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Income Tax Payable

1/1/10 Balance 0

Tax expense 6,000

12/31/10 Balance 0

Payments for taxes 6,000

Illustration 23-6Direct Method

LO 4


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Indirect Method

LO 4

Illustration 23-8

Computation of Net CashFlow from Operating Activities,Year 1Indirect Method

Common adjustments to Net Income (Loss):

Depreciation and amortization expense.

Gain or loss on disposition of long-term assets.

Change in current assets and current liabilities.


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Step 3: Determine Net Cash Flows from Investingand Financing Activities

Illustration 23-3

No long-term assets, thus no investing activities.

LO 5 Determine net cash f lows from inv est ing and f inancing act iv i t ies.


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Illustration 23-3

LO 5 Determine net cash f lows from inv est ing and f inancing act iv i t ies.

Purchase of common stock for $60,000 (Financing).


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Net income of $34,000 (Operating).

Dividends paid of $(14,000) (Financing).

LO 5 Determine net cash f lows from invest ing and f inancing act iv i t ies.


Illustration 23-3


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Statement of Cash Flows - 2010 Illustration 23-9

LO 6 Prepare a statement of cash flows.


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E23-6: Norman Companys financial statements for the year ended

December 31, 2010, contained the following condensed information.

Operating ActivitiesIndirect Method

2010 2009 Change

Revenues from fees 840,000


Depreciation expense 60,000

Loss on sale of equipment 26,000

Income before income tax 130,000

Income tax 40,000

Net income 90,000

Accounts receivable 37,000 59,000 ( 22,000)

Accounts payable 46,000 31,000 15,000

Income taxes payable 4,000 8,500 (4,500)

LO 4


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Cash flows from operating activities

Net income 90,000$

Adjustment to reconcile net income to net cash provided by operating activities:



Decrease in accounts receivable 22,000Increase in accounts payable 15,000

Decrease in income taxes payable (4,500)

Net cash provided by operating activities 208,500

E23-6: Prepare the operating activities section of the statement of cash

flows using the indirect method(Step 2).

Operating ActivitiesIndirect Method

LO 4Advance slide to uncover solution


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E23-5: Norman Companys financial statements for the year ended

December 31, 2010, contained the following condensed information.

Operating ActivitiesDirect Method

2010 2009 Change

Revenues from fees 840,000




Income before income tax 130,000

Income tax 40,000

Net income 90,000

Accounts receivable 37,000 59,000 ( 22,000)

Accounts payable 46,000 31,000 15,000

Income taxes payable 4,000 8,500 (4,500)

Assume accountspayable relates to

operatingexpenses.

LO 4


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E23-5: Prepare the operating activities section of the statement ofcash flows using the Direct method(Step 2).

LO 4 Contrast the direct and indirect method s of calculat ingnet cash f low from operat ing act iv i t ies.

Illustration 23-22


Accounts Receivable

1/1/10 Balance 59,000

Revenues 840,000

Receipts from customers 862,000

12/31/10 Balance 37,000


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Accounts Payable

1/1/10 Balance 31,000Operating expenses 624,000

12/31/10 Balance 46,000

Illustration 23-24


Payments to suppliers 609,000




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Income Tax Payable

1/1/10 Balance 8,500Income tax expense 40,000

12/31/10 Balance 4,000


Payments for income tax 44,500

Illustration 23-24




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Cash flows from operating activities

Cash receipts from customers $ 862,000

Cash paid for operating expenses (609,000)

Cash paid for income taxes (44,500)

Net cash provided by operating activities $ 208,500





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E23-2 (a):Plant assets that had cost25,000 6 years before

and were being depreciated on a straight-line basis over 10

years with no estimated scrap value were sold for5,300.


Step 3: Determine Net Cash Flow fromInvesting and Financing Activities

Plant assets (cost) 25,000

Accumulated depreciation ([25,000 / 10] x 6) 15,000

Book value at date of sale 10,000

Sale proceeds (5,300)

Loss on sale 2,700


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Cash flow from operating activitiesNet income (loss) ( 50,000)

Adjustment to reconcile net income to cash:

Loss on sale 2,700


Gain on sale (9,000)Cash from operations (34,300)

Cash flow from investing activities

Sale of plant assets 5,300

Sale of land 39,000

Cash from investing activities 44,300

Cash flow from financing activities

Sale of common stock 330,000

Purchase of company stock (47,000)

Cash from financing activities 283,000

Net Change in Cash 293,000

Statement of Cash Flows (a,b,d,h)

O

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E23-2 (b):During the year, 10,000 shares of common stockwith a stated value of $10 a share were issued for $33 a

share.

E23-2 (b)

Shares sold 10,000

Market value per share 33$

Value of shares 330,000$



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Loss on sale 2,700





Sale of land 39,000








O

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F


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E23-2 (d):The company sustained a net loss for the year of$50,000. Depreciation amounted to $22,000, and a gain of

$9,000 was realized on the sale of land for $39,000 cash.

E23-2 (d)



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Loss on sale 2,700





Sale of land 39,000








O

I

F


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E23-2 (h):During the year, treasury stock costing $47,000was purchased.

E23-2 (h)



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Loss on sale 2,700





Sale of land 39,000








O

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F


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23-43 LO 7 Ident i fy sources of informat ion for a statement of cash f lows.

Sources of Information for theStatement of Cash Flows

1. Comparative statements of financial position.

2. An analysis of the Retained Earnings.

3. Writedowns, amortization charges, and similar book

entries, such as depreciation, because they have no

effect on cash.


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Net Cash Flow from Operating ActivitiesIndirect Versus Direct Method

Adjustments Needed to Determine Net Cash Flowfrom Operating Activities.

Indirect Method

Illustration 23-18


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Illustration 23-21

Companies adjust each item in the incomestatement from the accrual basis to the cash basis.

Direct Method

LO 7


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23-46 LO 7 Ident i fy so urces of inform at ion for a statement o f cash f lows .

In Favor of the Direct Method

Shows operating cash receipts and payments. Information about cash receipts and payments is more

revealing of a companys ability

1. to generate sufficient cash from operating activities to pay

its debts,

2. to reinvest in its operations, and

3. to make distributions to its owners.


Direct Versus Indirect Controversy


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23-47 LO 7 Ident i fy so urces of inform at ion for a statement o f cash f lows .


Direct Versus Indirect Controversy

In Favor of the Indirect Method

Focuses on the differences between net income and net

cash flow from operating activities.

Provides link between the statement of cash flows and the

income statement and statement of financial position.


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Adjustments to Net Income

LO 8 Discuss sp ecial problems in prepar ing a statement of cash f lows.

Amortization of limited-life intangible assets.

Amortization of bond discount or premium.

Depreciation and Amortization

Postretirement Benefit Costs

Company must adjust net income by the difference

between cash paid and the expense reported.


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Affect net income but have no effect on cash.

Changes in Deferred Income Taxes

Equity Method of Accounting

Net increase in the investment account does not affect

cash flows.

Company must deduct the net increase from net income

to arrive at net cash flow from operating activities.


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A loss is added to net income to compute net cash flow

from operating activities because the loss is a non-cash

charge in the income statement.

Company reports a gain in the statement of cash flows as

part of the cash proceeds from the sale of equipment

under investing activities, thus it deducts the gain from

net income to avoid double-countingonce as part of netincome and again as part of the cash proceeds from the

sale.

Loss and Gains


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Cash is not affected by recording the expense.

The company must increase net income by the amount of

compensation expense from share options in computingnet cash flow from operating activities.

Share-Based Compensation


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Accounts Receivable (Net)


Because an increase in Allowance for Doubtful Accounts results

from a charge to bad debt expense, a company should add

back an increase in Allowance for Doubtful Accounts to net

income to arrive at net cash flow from operating activities.

Indirect Method

Illustration 23-28Accounts ReceivableBalances, Redmark Co.


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One methodof presenting this information in the statement

of cash flows:

Indirect Method

Illustration 23-29


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Alternate method(net approach) of presenting this

information in the statement of cash flows:

Indirect Method

Illustration 23-30


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Company should not netAllowance for Doubtful Accounts

against Accounts Receivable.

Direct Method

Illustration 23-31


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LO 8

Company should not net

Allowance for Doubtful Accounts

against Accounts Receivable.

Direct Method

Illustration 23-31

Cash sales should be reported at $85,000 ($100,000 - 9,000 - 6,000).

Increase in Accounts Receivable


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Some changes in working capital, although they affectcash, do not affect net income.

Purchase of short-term non-trading equity investments.

Issuance of a short-term non-trade note payable forcash.

Cash dividend payable.

Other Working Capital Changes



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Illustration: If the net loss is $50,000 and the total amount ofcharges to add back is $60,000, then net cash provided by

operating activities is $10,000.

Net Loss


Illustration 23-33Computation of Net CashFlow from Operating

ActivitiesCash Inflow


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Disclosures


Significant Non-Cash TransactionsCommon non-cash transactions that a company should

disclose:

1. Acquisition of assets by assuming liabilities (including financelease obligations) or by issuing equity securities.

2. Exchanges of non-monetary assets.

3. Refinancing of long-term debt.

4. Conversion of debt or preference shares to ordinary shares.

5. Issuance of equity securities to retire debt.


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Disclosures


Special DisclosuresIFRS requires companies to disclose:

Cash paid for taxes.

Cash flows from interest and dividends received and

paid.

The category (operating, investing, or financing) that each item

was included in must be disclosed as well.


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Use of a Worksheet

LO 9 Expla in the use of a wo rksheet in prepar ing a statement of cash f lows.

A worksheet involves the following steps.

Step 1. Enter the statement of financial position accounts and

their beginning and ending balances in the statement of financial

position accounts section.

Step 2. Enter the data that explain the changes in the statement

of financial position accounts and their effects on the statement of

cash flows in the reconciling columns of the worksheet.

Step 3. Enter the increase or decrease in cash on the cash line

and at the bottom of the worksheet. This entry should enable the

totals of the reconciling columns to be in agreement.


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Companies preparing financial statements under U.S. GAAP must

prepare a statement of cash flows as an integral part of the financialstatements.

Both IFRS and U.S. GAAP require that the statement of cash flows

should have three major sectionsoperating, investing, and financing

along with changes in cash and cash equivalents.

Similar to IFRS, the cash flow statement can be prepared using either

the indirect or direct method under U.S. GAAP. For both IFRS and U.S.

GAAP, companies choose for the most part to use the indirect method

for reporting net cash flow from operating activities.


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U.S. GAAP encourages companies to disclose the aggregate amount of

cash flows that are attributable to the increase in operating capacityseparately from those cash flows that are required to maintain operating

capacity.

The definition of cash equivalents used in IFRS is similar to that used in

U.S. GAAP.

IFRS requires that non-cash investing and financing activities be

excluded from the statement of cash flows. Instead, these non-cash

activities should be reported elsewhere.


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Cash Flows by Kieso

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