Cash Flow

Statement of Cash Flows
Preparation of the Statement

Usefulness Classification of cash flows Format of statement Steps in preparation Examples
Special Problems in Statement Preparation

Adjustments similar to depreciation Accounts receivable (net) Other working capital changes Net losses Gains Stock options Postretirement benefit costs Extraordinary items Significant noncash transactions
Use of a Worksheet
Preparation of worksheet Analysis of transactions Preparation of final statement
Sources of information
Indirect vs. direct method
Chapter 23-1
Section 1 - Preparation of the Statement of Cash Flows

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.
Chapter 23-2
LO 1 Describe the purpose of the statement of cash flows.
Usefulness of the of Cash Flows
Statement
Provides information to 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.
Chapter 23-3
LO 1 Describe the purpose of the statement of cash flows.
Classification of Cash Flows

Operating
Activities
Income
Investing
Activities
Generally Long-Term Asset Items
Financing
Activities
Generally Long-Term Liability and Equity Items
Statement
Items
The term Cash = Cash and cash equivalents.

Chapter 23-4
LO 2 Identify the major classifications of cash flows.

Cash and Cash Equivalent
Text Footnote 1, page 1245
1 The basis recommended by the FASB for the statement of cash flows is actually cash and cash equivalents. Cash equivalents are short-term, highly liquid investments that are both: (a) readily convertible to known amounts of cash, and (b) so near their maturity that they present insignificant risk of changes in interest rates. Generally, only investments with original maturities of three months or less qualify under this definition. Examples of cash equivalents are Treasury bills, commercial paper, and money market funds purchased with cash that is in excess of immediate needs.
Chapter 23-5

Classification of Typical Inflows and Outflows
Illustration 23-1
Income Statement Items
Chapter 23-6

Illustration 23-1
Generally Long-Term Asset Items

Chapter 23-7

Illustration 23-1
Generally Long-Term Liability and Equity Items
Chapter 23-8
Format of the Statement of Cash Flows

Order of Presentation:
1. 2. 3.
Operating activities. Investing activities. Financing activities.
Direct Method
Indirect Method
Report inflows and outflows from investing and financing activities separately.
Chapter 23-9
Format of the Statement of Cash Flows

Illustration 23-2
Chapter 23-10
Steps in Preparation
Three Sources of Information:
1. Comparative balance sheets
2. Current income statement 3. Selected transaction data
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.
Chapter 23-11
First Example - 2009

Illustration: Tax Consultants Inc. started on January 1,
2009, 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 balance sheets at the beginning and end of the year 2009 appear in Illustration 23-3. Illustration 23-4 shows the income statement and additional information for Tax Consultants.
Chapter 23-12

Comparative Balance Sheets, Year 1
Illustration 23-3
Income Statement, Year 1
Illustration 23-4
Chapter 23-13

Step 1: Determine the Change in Cash
Illustration 23-3
Chapter 23-14

Step 2: Determine the Net Cash Flow from Operating Activities
A company must determine revenues and expenses on a cash basis. Eliminate the 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 direct method or an indirect method.
Chapter 23-15

Step 2: Determine the Net Cash Flow from Operating Activities
Illustration 23-5
Chapter 23-16

Direct Method
Deducts operating cash disbursements from operating cash receipts.
Illustration 23-6
Net cash provided by operating activities is the equivalent of cash basis net income.
Chapter 23-17
LO 4 Contrast the direct and indirect methods of calculating net cash flow from operating activities.

Direct Method
Illustration 23-6
Accounts Receivable
1/1/09 Balance
Revenues 12/31/09 Balance
Chapter 23-18
0
125,000 36,000
Receipts from customers
89,000

Direct Method
Illustration 23-6
Accounts Payable
1/1/09
Payments for expenses 80,000
Balance
0
85,000 5,000
Operating expenses 12/31/09 Balance
Chapter 23-19

Direct Method
Illustration 23-6
Income Tax Payable

1/1/09
Payments for taxes 6,000
Balance
0
6,000 0
Tax expense 12/31/09 Balance
Chapter 23-20

Indirect Method
Adjusts net income for items not affecting cash.
Illustration 23-8
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.
Chapter 23-21

Step 3: Determine Net Cash Flows from Investing and Financing Activities
Illustration 23-3
No long-term assets, thus no investing activities.

Chapter 23-22
LO 5
Determine net cash flows from investing and financing activities.

Illustration 23-3
Chapter 23-23
Purchase of common stock for $60,000 (Financing).

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

Illustration 23-3

Chapter 23-24
Net income of $34,000 (Operating). Dividends paid of $(14,000) (Financing).

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

Statement of Cash Flows - 2009
Illustration 23-9
Chapter 23-25
LO 6 Prepare a statement of cash flows.
Operating Activities Indirect Method

E23-6: KRC Companys financial statements for the year ended December 31, 2010, contained the following condensed information.
Revenues from fees Operating expenses Depreciation expense Loss on sale of equipment Income before income tax Income tax Net income Accounts receivable Accounts payable Income taxes payable
Chapter 23-26
2010 $ 840,000 624,000 60,000 26,000 130,000 40,000 $ 90,000 $ 37,000 46,000 4,000
2009
Change
$ 59,000 31,000 8,500
$(22,000) 15,000 (4,500)
Operating Activities Indirect Method

E23-6: Prepare the operating activities section of the statement of cash flows using the indirect method (Step 2).
Cash flows from operating activities Net income Adjustment to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities
Chapter 23-27
$ 90,000
60,000 26,000 17,000 10,000 (4,500) 198,500
Solution on notes page
Operating Activities Direct Method

E23-5: KRC Companys financial statements for the year ended December 31, 2010, contained the following condensed information.
Revenues from fees Operating expenses Depreciation expense Loss on sale of equipment Income before income tax Income tax Net income Accounts receivable Accounts payable Income taxes payable
Chapter 23-28
2010 $ 840,000 624,000 60,000 26,000 130,000 40,000 $ 90,000 $ 37,000 46,000 4,000
2009
Change
Assume accounts payable relates to operating expenses.
$ 59,000 31,000 8,500
$(22,000) 15,000 (4,500)

E23-5: Prepare the operating activities section of the statement of cash flows using the Direct method (Step 2).
Illustration 23-22
Accounts Receivable
1/1/10 Balance Revenues 12/31/10 Balance 59,000 840,000 37,000
Receipts from customers 862,000
Chapter 23-29

Illustration 23-24
Accounts Payable
1/1/10 Payments to suppliers 609,000 Balance 31,000
Operating expenses
12/31/10 Balance
624,000
46,000
Chapter 23-30

Illustration 23-24
Income Tax Payable

1/1/10 Payments for income tax 44,500 Balance 8,500
Income tax expense

12/31/10 Balance
40,000
4,000
Chapter 23-31

Cash flows from operating activities Cash receipts from customers Cash paid for operating expenses Cash paid for income taxes Net cash provided by operating activities
$862,000 (609,000) (44,500) $208,500
Chapter 23-32
Solution on notes page
Step 3: Determine Net Cash Flow from Investing and Financing Activities
E23-2 (a): Plant assets that had cost $25,000 6 years
before and were being depreciated on a straight-line basis over 10 years with no estimated scrap value were sold for $5,300.
Plant assets (cost) Accumulated depreciation ([$25,000 / 10] x 6) Book value at date of sale Sale proceeds Loss on sale
Chapter 23-33
$ 25,000 15,000 10,000 (5,300) $ 2,700
LO 5
Statement of Cash Flows (a,b,d,h)

Statement of Cash Flows Cash flow from operating activities Net income (loss) Adjustment to reconcile net income to cash: Loss on sale Depreciation expense Gain on sale Cash from operations Cash flow from investing activities Sale of plant assets Sale of land Cash from investing activities Cash flow from financing activities Sale of common stock Purchase of company stock Cash from financing activities Net Change in Cash 330,000 (47,000) 283,000 $ 293,000 5,300 39,000 44,300 $ (50,000) 2,700 22,000 (9,000) (34,300)
I F
Chapter 23-34
E23-2 (b)
E23-2 (b): During the year, 10,000 shares of common stock with a stated value of $10 a share were issued for $33 a share.
Shares sold Market value per share Value of shares $ 10,000 33 $ 330,000
Chapter 23-35
LO 5

I F
Chapter 23-36
E23-2 (d)
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.
Chapter 23-37
LO 5

I F
Chapter 23-38
E23-2 (h)
E23-2 (h): During the year, treasury stock costing $47,000 was purchased.
Chapter 23-39
LO 5

I F
Chapter 23-40

I F
Chapter 23-41
Sources of Information for the Statement of Cash Flows

1. Comparative balance sheets. 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.
Chapter 23-42
LO 7 Identify sources of information for a statement of cash flows.
Net Cash Flow from Operating Activities Indirect Versus Direct Method
Adjustments Needed to Determine Net Cash Flow from Operating Activities Indirect Method
Illustration 23-18
Chapter 23-43
Net Cash Flow from Operating Activities Indirect Versus Direct Method
Direct Method - Companies adjust each item in the income statement from the accrual basis to the cash basis.
Illustration 23-21
Chapter 23-44
Direct Versus Indirect Controversy

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.
Chapter 23-45
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 balance sheet.
Special Rules Applying to Indirect Methods

Disclose Interest paid. Disclose Income taxes paid.
Chapter 23-46

1. Adjustments similar to depreciation Amortization of limited-life intangible assets.
Amortization of deferred costs.

Amortization of bond discount or premium. Changes in deferred income taxes. Change related to an investment when recording income or loss under the equity method.
Chapter 23-47
LO 8 Discuss special problems in preparing a statement of cash flows.

2. Accounts receivable, net 3. Other working capital changes 4. Net losses 5. Gains 6. Stock options 7. Postretirement benefits
8. Extraordinary items
9. Significant noncash transactions
Chapter 23-48
LO 8 Discuss special problems in preparing a statement of cash flows.

Cash Flow

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Cash Flow

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Statement of Cash Flows

Preparation of the Statement

Special Problems in Statement Preparation

Preparation of worksheet Analysis of transactions Preparation of final statement

Section 1 - Preparation of the Statement of Cash Flows

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

Usefulness of the of Cash Flows

Provides information to help assess:

2. Entitys ability to pay dividends and obligations.

4. Cash and noncash investing and financing transactions.

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

Classification of Cash Flows

The term Cash = Cash and cash equivalents.

LO 2 Identify the major classifications of cash flows.

Classification of Cash Flows

LO 2 Identify the major classifications of cash flows.

Classification of Cash Flows

Income Statement Items

LO 2 Identify the major classifications of cash flows.

Classification of Cash Flows

Generally Long-Term Asset Items

LO 2 Identify the major classifications of cash flows.

Classification of Cash Flows

Generally Long-Term Liability and Equity Items

LO 2 Identify the major classifications of cash flows.

Format of the Statement of Cash Flows

Operating activities. Investing activities. Financing activities.

LO 2 Identify the major classifications of cash flows.

Format of the Statement of Cash Flows

LO 2 Identify the major classifications of cash flows.

Three Major Steps:

Step 2. Determine net cash flow from operating activities.

LO 2 Identify the major classifications of cash flows.

First Example - 2009

LO 2 Identify the major classifications of cash flows.

First Example - 2009

Income Statement, Year 1

LO 2 Identify the major classifications of cash flows.

First Example - 2009

LO 2 Identify the major classifications of cash flows.

First Example - 2009

First Example - 2009

First Example - 2009

First Example - 2009

Receipts from customers

First Example - 2009

Operating expenses 12/31/09 Balance

First Example - 2009

Income Tax Payable

Tax expense 12/31/09 Balance

First Example - 2009

First Example - 2009

No long-term assets, thus no investing activities.

Determine net cash flows from investing and financing activities.

First Example - 2009

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

First Example - 2009

Net income of $34,000 (Operating). Dividends paid of $(14,000) (Financing).

First Example - 2009

LO 6 Prepare a statement of cash flows.

Operating Activities Indirect Method

$ 59,000 31,000 8,500

$(22,000) 15,000 (4,500)