CPA, MBA BY RACHELLE AGATHA, CPA, MBA Statement of Cash Flow Slides by Rachelle Agatha, CPA, with...

BY R A C H E L L E A G AT H A , C PA , M B A

Statement of Cash Flow

Slides by Rachelle Agatha, CPA, with excerpts from Warren, Reeve, Duchac

2

1. Summarize the types of cash flow activities reported in the statement of cash flows.

2. Prepare a statement of cash flows, using the indirect method.

3. Prepare a statement of cash flows, using the direct method.

Objectives:

3

Summarize the types of cash flow activities

reported in the statement of cash flows.

Objective 1

Objective 1

4

The statement of cash flows reports a firm’s major cash inflows

and outflows for a period. It provides useful information about a firm’s ability to generate cash from operations, maintain and expand its

operating capacity, meet its financial obligations, and pay

dividends.

5

Reporting Cash Flows

The statement of cash flows reports cash flows from three types of activities:1. Cash flows from operating activities

are cash flows from transactions that affect net income.

2. Cash flows from investing activities are cash flows from transactions that affect the investments in noncurrent assets.

3. Cash flows from financing activities are cash flows from transactions that affect the equity and debt of the business.

6

Statement of Cash Flows—NetSolutions

7

(payments for treasury stock, dividends, and redemption of debt

securities)

Financing

(payments for expenses)

Operating

Sources (increases) of Cash Uses (decreases) of Cash

(receipts from sales of noncurrent

assets)

Investing

(receipts from issuing equity

and debt securities)

Financing

(payments for acquiring noncurrent

assets)

Investing

(receipts from revenues)

Operating

Exhibit 2 Cash Flows

8

Cash Flows from Operating Activities

The direct method reports the sources of operating cash and the uses of operating cash.

9

The indirect method reports the operating cash flows by beginning

with net income and adjusting it for revenues and expenses that do not involve the receipt or payment of

cash.

10

Cash inflows from operating activities normally arise when cash is received from customers.

Cash outflows from operating activities normally arise when cash is paid to suppliers for merchandise, supplies, services and to employees for salaries and wages.

11

A primary advantage of the direct method is that it reports the sources and uses of operating cash flows in the statement of cash flow.

A primary disadvantage of the direct method is that the necessary data may not be readily available and may be costly to gather.

12

A primary advantage of the indirect method is that it focuses on the differences between net income and cash flows from operations.

Because the data are readily available, another advantage of the indirect method is that it is normally less costly to use than the direct method.

13

Cash Flows from Operations: Direct and Indirect Methods—NetSolutions

same amount

14

Cash Flows from Investing Activities

Cash inflows from investing activities normally arise from selling fixed assets, investments, and intangible assets.

Cash outflows from investing activities normally include payments to acquire fixed assets, investments, and intangible assets.

15

Cash Flows from Financing Activities

Cash inflows from financing activities normally arise from issuing debt or equity securities.

Cash outflows from financing activities normally include paying cash dividends, repaying debt, and acquiring treasury stock.

16

Noncash Investing and Financing Activities

Noncash investing and financing activities are

transactions that do not involve cash. The effect of such

transactions is recorded in a separate schedule that appears at

the bottom of the statement of cash flows.

17

I M P O R T A N T

The financial statements, including the statement of cash

flows, should not report cash flow per

share.

18

For each of the following, identify whether it would be disclosed as an operating, financing, or investing activity on the statement of cash flows under the indirect method.a.Purchase patentb.Pay cash

dividendc.Disposal of

equipment

d.Net incomee.Purchase treasury

stockf. Depreciation

expense

19

a. Purchase patentb. Pay cash dividendc. Disposal of

equipment

d.Net incomee.Purchase treasury

stockf. Depreciation

expense

a. Investing

b. Financing

c. Investing

d. Operating

e. Financing

f. Operating

20

Prepare a statement of

cash flows, using the indirect

method.

Objective 2

Objective 2

21

An efficient approach to preparing the statement of cash flows is to analyze the changes in the noncash balance sheet accounts. The logic of this approach is

that a change in any balance sheet account (including Cash) can be analyzed in terms of changes in the other balance

sheet accounts.

22

The analysis of Retained Earnings provides a good

starting point for determining the cash flows from operating

activities, which is the first section of the statement of

cash flows.

23

Comparative Balance Sheet

(Continued)

24

Comparative Balance Sheet

(Concluded)

25

Retained Earnings

The Retained Earnings account for Rundell Inc. reveals that the balance increased $80,000 during the year.

ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance202,300.00Dec.31 Net income 108,000.00310,300.00

31 Cash dividends28,000.00282,300.00

26

ACCOUNT Retained Earnings ACCOUNT NO. 32 Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance202,300.00Dec.31 Net income 108,000.00310,300.00

31 Cash dividends28,000.00282,300.00

The net income of $108,000 is entered on the statement (or working papers).

To statementTo statement

27

Operating Activities— Rundell Inc.

Cash flows from operating activities:Net income $108,000

Adjustments to reconcile net income to net cash flow from operating activities:

This phrase is added to indicate that accrual basis

net income is being adjusted to arrive at cash

flows from operations.

This phrase is added to indicate that accrual basis

net income is being adjusted to arrive at cash

flows from operations.

28

Next, we need to determine depreciation expense for the year. If it isn’t given in the

income statement, sometimes it can be found by analyzing

the various accumulated depreciation accounts.

Depreciation

29

ACCOUNT Accumulated Depreciation—Building ACCT. NO. Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 58,300.00Dec.31 Depr. for year 7,000.00 65,300.00

to statementto statement

The comparative balance sheet indicates that Accumulated Depreciation—Building increased by $7,000. By analyzing the account we can see that the increase is the result of the year-end adjusting entry.

30

The offsetting $7,000 debit is to an expense for

depreciation. The effect on the income statement was

to reduced net income; however, this expense did not require an outflow of

cash. Therefore, the $7,000 is added back to net income in determining cash

flows from operating activities.

31

Amortization is treated in the same manner as depreciation.



Depreciation 7,000

Operating Activities—Rundell Inc.

32

Gain on Sale of Land

The ledger or income statement of Rundell Inc. indicates that the sale of

land resulted in a gain of $12,000. This gain increased net income by $12,000,

yet cash flows was provided by an investing activity (selling land) rather

than an operating activity, so the gain is deducted from net income on the

statement of cash flows.

33

Operating Activities—Rundell Inc.



Depreciation 7,000Gain on sale of land (12,000)

34

Omni Corporation’s accumulated depreciation increased by $12,000, while patents decreased by $3,400 between balance sheet dates. There were no purchases or sales of depreciable or intangible assets during the year. In addition, the income statement showed a gain of $4,100 from sale of land. Reconcile a net income of

$50,000 to net cash flow from operating activities.

35

Net income $50,000Adjustments to reconcile net income from operating activities:

Depreciation 12,000Amortization 3,400Gain on sale of land (4,100)

Net cash flow from operating activities$61,300

36

Next, select current assets and current liabilities that

impact cash flows and determine their increases

and decreases. Exhibit 5 in the next slide my prove to be helpful in determining how

to treat increases and decreases in noncash

current operating assets and current operating liabilities.

Changes in Current Operating Assets and Liabilities

37

Adjustments to Net Income (Loss) Using the Indirect Method

38

Changes in Current Accounts

Accounts

Accounts receivable (net) $ 74,000 $ 65,000Inventories 172,000 180,000Accounts payable (mdse.) 43,500 46,700Accrued expenses payable 26,500 24,300Income taxes payable7,900 8,400

9,0008,000*

3,200*2,200500*

2008 2007

December 31 Increase Decrease*

Note that Cash and Dividends Payable are not included in this analysis.

39



Depreciation 7,000Gain on sale of land (12,000)

Changes in current operating assets and liabilities:

Increase in accounts receivable(9,000)Decrease in inventory 8,000Decrease in accounts payable (3,200)Increase in accrued expenses 2,200Decrease in income taxes payable(500)

Operating Activities—Indirect Method

You will notice that increases actually decrease cash flows from operating activities, and decreases do just the

opposite.

40

Statement of Cash Flows—Indirect Method for Rundell Inc. (Operating Activities Section)

Same information as Slide 39, only in final form.

41

Victor Corporation’s comparative balance sheet for current assets and current liabilities

was as follows:

Dec. 31, 2009 Dec. 31, 2008Accounts receivable $ 6,500 $ 4,900

Inventory 12,300 15,000Accounts payable 4,800 5,200Dividends payable 5,000 4,000

Adjust net income of $70,000 for changes in operating assets and liabilities.

42

Net income $70,000Adjustments to reconcile net income to net cash from from operating activities:

Increase in accounts receivable (1,600)Decrease in inventory 2,700Decrease in accounts payable (400)

Net cash flow from operating activities $70,700

43

Omicron, Inc. reported the following data:

Prepare the cash flow for operating activities section of the statement of cash flows using the indirect method.

Net income $120,000Depreciation expense 12,000Loss on disposal of equipment15,000Increase in Accounts receivable5,000Decrease in Accounts payable(2,000)

44



Depreciation 12,000Loss from disposal of equipment 15,000Changes in current operating assets

and liabilities:

Increase in accounts receivable(5,000)Decrease in accounts payable (2,000)

Net cash flow from operating activities $140,000

45

Cash Flows Used for Payment of Dividends

ACCOUNT Dividends Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 10,000

10 Cash paid 10,000 —June20 Dividends declared 14,000 14,000July 10 Cash paid 14,000 —Dec. 20 Dividends declared 14,000 14,000

Note that while $28,000 in dividends were declared, only $24,000 were paid during the

year.

46

Because paying of dividends affects equity

and is an outflow of cash, it is a negative $24,000 cash flows

from financing activities transaction.

47

Common Stock

Common Stock increased by $8,000.

ACCOUNT Common Stock ACCOUNT NO. Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 16,000Nov. 1 4,000 shares issued/cash 8,000 24,000

48

ACCOUNT Paid-in Capital in Excess of Par—Common Stock Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 80,000Nov. 1 4,000 shares issued/cash 40,000 120,000

Analyzing the two accounts together, we can determine that the 4,000 shares were sold for $48,000.

49

Issuing common stock affects equity; therefore, we

have a positive $48,000 cash flows from financing

activities item.

50

Bonds Payable

Bonds Payable decreased by $50,000.

ACCOUNT Bonds Payable ACCOUNT NO. Balance Date Item Debit Credit Debit Credit

2008Jan. 1 Balance 150,000June 30 Retired by payment of

cash at face amount50,000 100,000

51

Retiring bonds is a cash outflow reported as a negative item under

cash flows from financing activities.

52

Building

ACCOUNT Building ACCOUNT NO. Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 200,000Dec.27 Purchased for cash 60,000 260,000

By examining the Building account, we can determine that Rundell Inc. bought a building for $60,000 cash.

53

Purchasing a building involves a noncurrent

asset, so this is a negative cash flows from

investing activity.

54

Land

ACCOUNT Land ACCOUNT NO. Balance Date Item Debit Credit Debit Credit2008Jan. 1 Balance 125,000June 8 Sold for $72,000 cash 60,000 65,000Oct. 12 Purchased for $15,000

cash 15,000 80,000

The $45,000 decline in the Land account resulted from two separate transactions: a sale and a purchase.

55

The first transaction, the sale of land, is classified as

a positive cash flows from investing activity because land is a noncash

asset.

56

The $12,000 gain was recorded earlier on

Slide 34 as an operating activity. The purchase of land also

is an investing activity.

57

The second transaction is the purchase of land for cash of $15,000. This transaction is

reported as an outflow of cash in the cash

flows from investing activities section.

58

Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement)

59

Statement of Cash Flows—Indirect Method for Rundell Inc. (Partial Statement)

The ending balance in the Cash account should match this amount.

60

Alpha Corporation purchased land for $125,000. Later in the year the company

sold land with a book value of $165,000 for $200,000. How are the effects of these

transactions are reported on the statement of cash flows?

61

The gain on sale of land is deducted from net income as shown below:

Gain on sale of land $(35,000)

Cash received for sale of land$200,000Cash paid for purchase of land(125,000)

The purchase and sale of land is reported as part of cash inflow form investing activities as shown below:

62

Prepare a statement of

cash flows, using the direct method.

Objective 3Objective 3

63

The final amount for cash flows from

operating activities will be the same

whether the direct or indirect approach

is used. The methods differ in how the data are

obtained, analyzed, and reported.

The Direct Method

64

Data for Direct Method

Rundell Inc.Schedule of Changes in Current AccountsDecember

31 Accounts 2008 2007

Incr/Decr*

Cash $ 97,500 $ 26,000 $71,500Accounts receivable (net) 74,000 65,000 9,000Inventories 172,000 180,000 8,000*Accounts payable (merchandise creditors) 43,500 46,700 3,200*Accrued exp payable (operating expenses) 26,500 24,300 2,200Income taxes payable 7,900 8,400 500*Dividends payable 14,000 10,000 4,000

(Continued)

65

Sales$1,180,000 Cost of merchandise sold 790,000 Gross profit $ 390,000Operating expenses:

Depreciation expense $ 7,000 Other operating expenses 196,000

Total operating expenses 203,000Income from operations $ 187,000Other income:

Gain on sale of land $ 12,000

Other expense:Interest expense 8,000

4,000 Income before income tax $ 191,000Income tax 83,000

Net income $ 108,000

Rundell Inc.Income StatementFor the Year Ended December 31, 2008

(Concluded)

66

Cash Received from Customers

The $1,180,000 of sales for Rundell Inc. is reported

using the accrual method. An adjustment is necessary

to convert the sales reported on the income statement to

the cash method.

67










ChangesCash receivedfrom customers

Sales $1,180,000

Cash received from customers$1,171,000

Increase in accounts rec. (9,000)

68










ChangesCash receivedfrom customers

Sales $1,180,000Increase in accounts rec. (9,000)

Cash received from customers $1,171,000

CASH BASIS

$1,171,000

69

Sales reported on the income statement were $350,000. The accounts receivable balance declined $8,000 over the year. Determine the amount of cash received

from customers.

Sales $350,000Add decrease in accounts receivable 8,000Cash received from customer $358,000

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Cash Payments for Merchandise









CASH BASIS

$1,171,000

Cash payments formerchandise Changes

Cost of merchandise sold

$790,000

71









CASH BASIS

$1,171,000


ChangesCash payments formerchandise

Decrease in inventories (8,000)Decrease in accounts payable

3,200Cash payments formerchandise $785,200

$790,000

72









CASH BASIS

$1,171,000(785,200)


ChangesCash payments formerchandise

Decrease in inventories (8,000)Decrease in accounts payable

3,200Cash payments formerchandise $785,200

$790,000

73

Cost of merchandise sold reported on the income statement was $145,000. The accounts payable balance increased $4,000, and the inventory balance increased by $9,000 over the year.

Determine the amount of cash paid for merchandise.

Cost of merchandise sold $145,000Add increase in inventories 9,000Deduct increase in accounts payable (4,000)Cash payments for merchandise $150,000

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Cash Payments for Operating Expenses









CASH BASIS

$1,171,000(785,200)

75









CASH BASIS

$1,171,000(785,200)

0

There is no cash flow for depreciation

expense.

There is no cash flow for depreciation

expense.

76









CASH BASIS

$1,171,000(785,200)

0

Changes

Operating expenses (other thandepreciation)

Changes

Cash payments for operating expenses

(193,800)

$196,000Increase in accrued exp (2,200)

Cash payments for operatingexpenses $193,800

77









CASH BASIS

$1,171,000(785,200)

0(193,800)

0


To avoid confusion,

page numbers for the

remaining slides are

centered on the slides.

The gain on sale of land of $12,000 is included in the proceeds from the

sale of land, which is reported as part of cash flows from investing

activities.

The gain on sale of land of $12,000 is included in the proceeds from the

sale of land, which is reported as part of cash flows from investing

activities.

78









CASH BASIS

$1,171,000(785,200)

0(193,800)

0


Interest expense

ChangesCash paid forinterest expense

8,000

+/- decrease/increase in payable 0

Cash payments for interest$8,000

(8,000)

79









CASH BASIS

$1,171,000(785,200)

0(193,800)

0

Cash Payments for Income Taxes

(8,000)

Income tax expense

ChangesCash payments for income taxes

$83,000

Add decrease in income taxes payable 500

Cash payments for income tax$83,500

(83,500)

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CASH BASIS

$1,171,000(785,200)

0(193,800)

0

Cash Payments for Income Taxes

(8,000)

(83,500)$ 100,500

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Statement of Cash Flows—Direct Method (Operating Activities Section)

(Continued)

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Statement of Cash Flows—Direct Method (Reconciliation)

A reconciliation is required when the direct method is used.

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Financial Analysis and Interpretation

Free cash flow is a measure of operating cash flow available for

corporate purposes after providing sufficient fixed asset additions to maintain current

productive capacity and dividends.

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Cash flow from operations

Less: Investments in fixed assets to maintain current production

Free cash flow

Free Cash Flow

Positive free cash flow is considered favorable. A company that has free cash flow is able to fund internal growth, retire debt, pay dividends, and

enjoy financial flexibility.

Summary

Types of Cash Flow Activities

Indirect Method of Cash Flow

Direct Method of Cash Flow

CPA, MBA BY RACHELLE AGATHA, CPA, MBA Statement of Cash Flow Slides by Rachelle Agatha, CPA, with...

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