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Chapter

13

Statement of Cash Flows


Financial Accounting, IFRS Edition Weygandt Kimmel Kieso
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Study Objectives
1. Indicate the usefulness of the statement of cash flows. 2. Distinguish among operating, investing, and financing activities. 3. Prepare a statement of cash flows using the indirect method.

4. Analyze the statement of cash flows.

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Statement of Cash Flows

The Statement of Cash Flows: Usefulness and Format


Usefulness Classifications Significant non-cash activities Format Preparation Indirect and direct methods

Preparing the Statement of Cash FlowsIndirect Method


Step 1: Operating activities Step 2: Investing and financing activities Step 3: Net change in cash

Using Cash Flows to Evaluate a Company

Free cash flow

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Usefulness and Format


Usefulness of the Statement of Cash Flows
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 provided (used) by operating activities. 4. Cash investing and financing transactions during the period.

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SO 1 Indicate the usefulness of the statement of cash flows.

Usefulness and Format


Classification of Cash Flows
Operating Activities
Income Statement Items

Investing Activities
Generally Non-Current Asset Items

Financing Activities
Generally Non-Current Liability and Equity Items

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SO 2 Distinguish among operating, investing, and financing activities.

Classification of Cash Flows


Types of Cash Inflows and Outflows
Illustration 13-1

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SO 2 Distinguish among operating, investing, and financing activities.

Classification of Cash Flows


Types of Cash Inflows and Outflows
Illustration 13-1

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SO 2 Distinguish among operating, investing, and financing activities.

Classification of Cash Flows


Types of Cash Inflows and Outflows
IFRS requires that the following amounts be disclosed:
Cash paid for taxes. Cash received and paid from interest and dividends.
Illustration 13-2 Daimlers statement of cash flows note

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SO 2 Distinguish among operating, investing, and financing activities.

Usefulness and Format


Significant Non-Cash Activities
1. Direct issuance of ordinary shares to purchase assets.
2. Conversion of bonds into ordinary shares. 3. Direct issuance of debt to purchase assets.

4. Exchanges of plant assets.


Companies report these activities in either a separate note or supplementary schedule to the financial statements.

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SO 2 Distinguish among operating, investing, and financing activities.

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Usefulness and Format


Format of the Statement of Cash Flows
Order of Presentation:
1. Operating activities. 2. Investing activities. 3. Financing activities.
The cash flows from operating activities section always appears first, followed by the investing and financing sections.

Direct Method Indirect Method

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SO 2 Distinguish among operating, investing, and financing activities.

Format of the Statement of Cash Flows


Illustration 13-3

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SO 2 Distinguish among operating, investing, and financing activities.

Format of the Statement of Cash Flows


During its first week, Hu Na Company had these transactions.

Classification
1. Issued 100,000 HK$50 par value ordinary shares for HK$8,000,000 cash. 2. Borrowed HK$2,000,000 from Castle Bank, signing a 5-year note bearing 8% interest. 3. Purchased two semi-trailer trucks for HK$1,700,000 cash. 4. Paid employees HK$120,000 for salaries and wages. 5. Collected HK$200,000 cash for services provided.
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Financing

Financing
Investing Operating Operating

SO 2 Distinguish among operating, investing, and financing activities.

Usefulness and Format


Preparing the Statement of Cash Flows
Three Sources of Information:
1. Comparative statement of financial position 2. Current income statement 3. Additional information

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SO 2 Distinguish among operating, investing, and financing activities.

Usefulness and Format


Three Major Steps:
Illustration 13-4

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SO 2 Distinguish among operating, investing, and financing activities.

Usefulness and Format


Three Major Steps:
Illustration 13-4

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SO 2 Distinguish among operating, investing, and financing activities.

Usefulness and Format


Indirect and Direct Methods
Companies favor the indirect method for two reasons:
1. Easier and less costly to prepare, and 2. Focuses on the differences between net income and net cash flow from operating activities.

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SO 2 Distinguish among operating, investing, and financing activities.

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Preparing the Statement of Cash Flows


Illustration
Illustration 13-5

Indirect Method

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SO 3 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows


Indirect Method
Illustration 13-5

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SO 3 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows


Additional information for 2011: 1. The company declared and paid a $29,000 cash dividend. 2. Issued $110,000 of long-term bonds in direct exchange for land.

3. A building costing $120,000 and equipment costing $25,000 were purchased for cash.
4. The company sold equipment with a book value of $7,000 (cost $8,000, less accumulated depreciation $1,000) for $4,000 cash. 5. Issued ordinary shares for $20,000 cash. 6. Depreciation expense was comprised of $6,000 for building and $3,000 for equipment.

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SO 3 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows


Step 1: Operating Activities
Indirect Method

Determine net cash provided/used by operating activities by converting net income from an accrual basis to a cash basis. Common adjustments to Net Income (Loss):
Add back non-cash expenses (depreciation and amortization expense). Deduct gains and add losses that resulted from investing and financing activities.

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Analyze changes in non-cash current assets and current liabilities.


SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities

Question
Which is an example of a cash flow from an operating activity? a. Payment of cash to lenders for interest. b. Receipt of cash from the sale of shares.

c. Payment of cash dividends to the companys shareholders.


d. None of the above.

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Depreciation Expense
Although depreciation expense reduces net income, it does not
reduce cash.
Illustration 13-7

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Loss on Sale of Equipment
Because companies report as a source of cash in the investing

activities section the actual amount of cash received from the


sale: Any loss on sale is added to net income in the operating

section.
Any gain on sale is deducted from net income in the operating section.

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Loss on Sale of Equipment
Computer Services income statement reports a $3,000 loss on the sale of equipment (book value $7,000, less $4,000 cash received from sale of equipment).
Illustration 13-8

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Asset Accounts
When the Accounts Receivable balance decreases, cash receipts are higher than revenue earned under the accrual basis.
Illustration 13-9

Accounts Receivable 1/1/011 Balance Revenues 30,000 507,000 20,000 Receipts from customers 517,000

12/31/11 Balance

Therefore, the company adds to net income the amount of the decrease in accounts receivable.
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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Asset Accounts
Illustration 13-10

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Net cash provided by operating activities $ 9,000 3,000 10,000 167,000 $ 145,000

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Asset Accounts
When the Inventory balance increases, the cost of merchandise purchased exceeds the cost of goods sold.
Merchandise Inventory 1/1/11 Balance Purchases 10,000 155,000 15,000 Cost of goods sold 150,000

12/31/11 Balance

As a result, cost of goods sold does not reflect cash payments made for merchandise. The company deducts from net income this inventory increase.
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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Asset Accounts
Illustration 13-10

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Net cash provided by operating activities $ 9,000 3,000 10,000 (5,000) 162,000 $ 145,000

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Asset Accounts
When the Prepaid Expense balance increases
Cash paid for expenses is higher than expenses reported on an accrual basis.

Company deducts the increase from net income to arrive at net cash provided by operating activities.

If prepaid expenses decrease, reported expenses are higher than the expenses paid.

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Asset Accounts
Illustration 13-10

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Net cash provided by operating activities
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145,000

9,000 3,000 10,000 (5,000) (4,000) $ 158,000

SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Liability Accounts
When Accounts Payable increases
Company received more in goods than it actually paid for. Increase is added to net income.

When Income Tax Payable decreases


Income tax expense was less than the amount of taxes paid during the period. Decrease is subtracted from net income.

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SO 3 Prepare a statement of cash flows using the indirect method.

Operating Activities
Changes to Non-Cash Current Liability Accounts
Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities
Slide 13-35 Illustration 13-11

145,000

9,000 3,000 10,000 (5,000) (4,000) 16,000 (2,000) $ 172,000

SO 3 Prepare a statement of cash flows using the indirect method.

Preparing the Statement of Cash Flows


Summary of Conversion to Net Cash Provided by Operating ActivitiesIndirect Method
Illustration 13-12

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SO 3 Prepare a statement of cash flows using the indirect method.

Step 2: Investing and Financing Activities


From the additional information, the company purchased land of $110,000 by issuing long-term bonds. This is a significant noncash investing and financing activity that merits disclosure in a separate schedule.
Land

1/1/11

Balance Issued bonds

20,000 110,000
130,000 Bonds Payable 1/1/11 Balance For land 20,000 110,000 130,000

12/31/11 Balance

12/31/11 Balance
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SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities


Partial statement
Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of ordinary shares Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Disclosure: Issuance of bonds to purchase land
Slide 13-38 Illustration 13-14

172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000 110,000

$ $

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities


From the additional information, the company acquired an office

building for $120,000 cash. This is a cash outflow reported in


the investing section.
Building 1/1/11 Balance 40,000 Office building 120,000 160,000

12/31/11 Balance

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SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities


Partial statement
Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of ordinary shares Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Disclosure: Issuance of bonds to purchase land
Slide 13-40 Illustration 13-14

172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000 110,000

$ $

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities


The additional information explains that the equipment increase resulted from two transactions: (1) a purchase of equipment of $25,000, and (2) the sale for $4,000 of equipment costing $8,000.
Equipment 1/1/11 Balance Purchase 10,000 25,000 Equipment sold 8,000

12/31/11 Balance

27,000 Cash Accumulated depreciation Loss on sale of equipment Equipment 4,000 1,000 3,000
8,000

Journal Entry

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SO 3 Prepare a statement of cash flows using the indirect method.

Statement of Cash Flows


Indirect Method

Illustration 13-14 Slide 13-42

Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of ordinary shares Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period

145,000

9,000 3,000 10,000 (5,000) (4,000) 16,000 (2,000) 172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities


The additional information notes that the increase in share
capital - ordinary resulted from the issuance of new shares.
Ordinary Shares 1/1/11 Balance Shares sold 50,000 20,000 70,000

12/31/11 Balance

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SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities


Partial statement
Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of ordinary shares Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period Disclosure: Issuance of bonds to purchase land
Slide 13-44 Illustration 13-14

172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000 110,000

$ $

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities


Retained earnings increased $116,000 during the year. This increase can be explained by two factors: (1) Net income of $145,000 increased retained earnings. (2) Dividends of $29,000 decreased retained earnings
Retained Earnings 1/1/11 Dividends 29,000 Balance Net income 48,000 145,000 164,000

12/31/11 Balance

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SO 3 Prepare a statement of cash flows using the indirect method.

Statement of Cash Flows


Indirect Method

Step 3: Net Change in Cash


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Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Depreciation expense Loss on sale of equipment Decrease in accounts receivable Increase in inventory Increase in prepaid expenses Increase in accounts payable Decrease in income taxes payable Net cash provided by operating activities Cash flows from investing activities: Purchase of building Purchase of equipment Sale of equipment Net cash used by investing activities Cash flows from financing activities: Issuance of ordinary shares Payment of cash dividends Net cash used by financing activities Net increase in cash Cash at beginning of period Cash at end of period

Illustration 13-14

145,000

9,000 3,000 10,000 (5,000) (4,000) 16,000 (2,000) 172,000 (120,000) (25,000) 4,000 (141,000) 20,000 (29,000) (9,000) 22,000 33,000 55,000

SO 3 Prepare a statement of cash flows using the indirect method.

Investing and Financing Activities

Question
Which is an example of a cash flow from an investing activity? a. Receipt of cash from the issuance of bonds payable. b. Payment of cash to repurchase outstanding shares. c. Receipt of cash from the sale of equipment. d. Payment of cash to suppliers for inventory.

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SO 3 Prepare a statement of cash flows using the indirect method.

Using Cash Flows to Evaluate a Company


Free Cash Flow

Free cash flow describes the cash remaining from operations after adjustment for capital expenditures and dividends.

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SO 4 Analyze the statement of cash flows.

Using Cash Flows to Evaluate a Company

Illustration 13-16

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SO 4 Analyze the statement of cash flows.

Understanding U.S. GAAP


Key Differences
Statement of Cash Flows

Companies preparing financial statements under both IFRS and


GAAP must prepare a statement of cash flows as an integral part of the financial statements. Both IFRS and GAAP require that the statement of cash flows should have three major sectionsoperating, investing, and financingalong 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 GAAP. In both U.S. and international settings, most companies choose the indirect method for reporting net cash flows from operating activities.
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Understanding U.S. GAAP


Key Differences
Statement of Cash Flows

The definition of cash equivalents used in GAAP is similar to


that used in IFRS. A major difference is that in certain situations, bank overdrafts are considered part of cash and cash equivalents under IFRS, which is not the case in GAAP.

Under GAAP, bank overdrafts are classified as financing


activities. IFRS requires that non-cash investing and financing activities be excluded from the statement of cash flows. Non-cash investing and financing activities should be disclosed in the notes instead of in the financial statements. Under GAAP, companies may present this information at the bottom of the
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cash flow statement.

Understanding U.S. GAAP


Looking to the Future
Statement of Cash Flows

Presently, the FASB and the IASB are involved in a joint project on
the presentation and organization of information in the financial statements. One interesting approach, revealed in a published proposal from that project, is that in the future the income

statement and statement of financial position would adopt headings


similar to those of the statement of cash flows. That is, the income statement and statement of financial position would be broken into operating, investing, and financing sections. With respect to the

cash flow statement specifically, the notion of cash equivalents will


probably not be retained. That is, cash equivalents will not be combined with cash but instead will be reported as a form of highly
continued Slide 13-52

Understanding U.S. GAAP


Looking to the Future
Statement of Cash Flows

liquid, low-risk investments. The definition of cash in the existing


literature would be retained, and the statement of cash flows would present information on changes in cash only. In addition, the FASB favors presentation of operating cash flows using the direct method

only. However, the majority of IASB members express a preference


for not requiring use of the direct method of reporting operating cash flows. So, the two Boards will have to resolve their differences in this area in order to issue a converged standard for the statement

of cash flows.

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Using a Worksheet to Prepare the Statement of Cash Flows-Indirect Method

Appendix A

Illustration 13A-1 Slide 13-54

SO 5 Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.

Using a Worksheet to Prepare the Statement of Cash Flows-Indirect Method

Preparing a Worksheet
1. Enter in the statement of financial position accounts section the statement of financial position accounts and their beginning and ending balances. 2. Enter in the reconciling columns of the worksheet the data that explain the changes in the statement of financial position accounts other than cash and their effects on the statement of cash flows. 3. Enter the cash line and at the bottom of the worksheet the increase or decrease in cash. This entry should enable the totals of the reconciling columns to be in agreement.
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SO 5 Explain how to use a worksheet to prepare the statement of cash flows using the indirect method.

Using a Worksheet to Prepare the Statement of Cash Flows-Indirect Method

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Illustration 13A-3 Completed worksheet indirect method

Statement of Cash Flows-Direct Method


Appendix B
1. Under the direct method, companies compute net cash provided by operating activities by adjusting each item in the income statement from the accrual basis to the cash basis. 2. To simplify and condense the operating activities section, companies report only major classes of operating cash receipts and cash payments. 3. For these major classes, the difference between cash receipts and cash payments is the net cash provided by operating activities.

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Step 1: Operating Activities
Illustration 13B-2

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Illustration 13B-1

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Illustration 13B-1

Additional information: 1. In 2011, the company declared and paid a $32,000 cash dividend. 2. Bonds were issued at face value for $130,000 in cash. 3. Equipment costing $180,000 was purchased for cash. 4. Equipment costing $20,000 was sold for $17,000 cash when the book value of the equipment was $18,000. 5. Ordinary shares of $60,000 were issued to acquire land.
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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Cash Receipts from Customers
For Juarez Company, accounts receivable decreased $3,000.
Illustration 13B-3

Illustration 13B-5

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Cash Payments to Suppliers
In 2011, Juarez Companys inventory increased $10,000 and cash payments to suppliers were $678,000.
Illustration 13B-6 Illustration 13B-7

Illustration 13B-9

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Cash Payments for Operating Expenses
Cash payments for operating expenses were $179,000,
Illustration 13B-10

Illustration 13B-11

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Cash Payments for Income Taxes
Cash payments for income taxes were $24,000,
Illustration 13B-12

Illustration 13B-13

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Step 2: Investing and Financing Activities
Increase in Equipment. (1) Juarez purchased for cash equipment costing $180,000. And (2) it sold for $17,000 cash equipment costing $20,000, whose book value was $18,000.
Illustration 13B-15

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SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Step 2: Investing and Financing Activities
Increase in Land. Juarezs land increased $60,000. The additional information section indicates that the company issued ordinary shares to purchase the land.
Increase in Bonds Payable. Bonds Payable increased $130,000. The additional information indicated that Juarez issued, for $130,000 cash, bonds with a face value of $130,000.
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Significant non-cash investing and financing transaction.

Financing activity.

SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Step 2: Investing and Financing Activities
Increase in Share Capital - Ordinary. The Share Capital - Ordinary account increased $60,000. The additional information indicated that Juarez acquired land from the issuance of ordinary shares.
Increase in Retained Earnings. The $52,000 net increase in Retained Earnings resulted from net income of $84,000 and the declaration and payment of a cash dividend of $32,000.
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Significant non-cash investing and financing transaction.

Financing activity (cash dividend).

SO 6 Prepare a statement of cash flows using the direct method.

Statement of Cash Flows-Direct Method


Step 2: Investing and Financing Activities

Step 3: Net Change in Cash


Illustration 13B-16 Slide 13-68

SO 6 Prepare a statement of cash flows using the direct method.

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